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Leverage Example

  • There are three types of leverage:
  • 1. Negative Leverage - This is also called unsuccessful leverage because the investor or lender ends up losing on their money invested in the deal.

  • 2. Neutral Leverage - This is called neutral leverage because the investor or lender ends up breaking even on their money invested in the deal.

  • 3. Positive Leverage - This is also called successful leverage because the investor or lender ends up making a profit on their money invested in the deal.

  • Vo or Price = $100,000

  • Ym = 10%

  • Rate = Income/Value

  • ADS = $100,000 x 10% which equals $10,000. ADS stands for the Annual Debt Service. Meaning that the total mortgage payments for the year on this loan will be $10,000.

Let's say you were buying an investment property for $100,000 and your mortgage interest rate was 10%. If your rate of return on this investment is greater than 10%, than you have positive leverage. You have positive leverage because the return on investment exceeds the interest rate you pay as the borrower of the money needed to purchase the property.

Let's say this property has a $15,000 total positive cash flow for the year. A positive cash flow simply means that the rental income from the apartments can pay all of the bills on the property each month, and there will still be extra money left over.

$15,000/$100,000  =   .15
or
15% rate of return

The 15% rate of return on investment is greater than the 10% you're being charged by the bank for the mortgage funds. Therefore, you have positive leverage on this deal. That's the way to go!

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