Leverage
Definition and meaning of Leverage in real estate.
Leverage is the use of borrowed capital, such as a mortgage loan, to purchase a real estate asset with the goal of increasing the potential return on investment. By using other people's money, an investor can acquire a larger property than they could buy with cash alone.
In more detail
Using leverage allows a buyer to control a high-value asset with a relatively small down payment. If the property appreciates, the investor earns a return based on the total value of the home, not just the cash they invested, which amplifies their profits. However, leverage also increases risk, as it magnifies potential losses if the property value declines.
If the rental income does not cover the mortgage payments, the investor will face negative cash flow. Lenders typically limit leverage by requiring a minimum down payment to protect themselves against borrower default.
Key facts
| Category | Real Estate Investing |
|---|---|
| Also known as | Debt financing, gearing |
| Applies to | Residential home buyers, commercial investors, and developers |
| Watch out for | Higher risk of foreclosure and negative cash flow if market drops |
An investor uses leverage by putting down twenty percent cash to buy a rental property, borrowing the remaining eighty percent through a mortgage.
Frequently asked questions
What are the risks of using too much leverage?
High leverage increases your monthly mortgage payment, making you more vulnerable to default if rental income falls or if property values decline below the loan balance.
How does leverage increase return on investment?
It allows you to earn appreciation on the full value of the property while only investing a fraction of your own cash as a down payment.
Related terms
Sources & references
See our sources and editorial standards.