Quick Answer
Leverage is the use of borrowed capital to control a larger position than equity alone would allow - magnifying both gains and losses on the underlying asset.
Key Takeaways
- Higher leverage means higher potential returns and higher potential losses.
- Leverage ratio is a fundamental measure of risk exposure.
- Sustainable leverage is calibrated to income stability and asset volatility.
The Mechanics
Buying a $400,000 property with $80,000 down and a $320,000 mortgage represents 5:1 leverage. A 10% appreciation in the asset produces a 50% return on the down payment - and a 10% decline produces a 50% loss.
Frequently Asked Questions
What is a safe amount of leverage?
Educational sources note that safety depends on the volatility of the underlying asset, the borrower's income stability, and the cost of the debt. There is no single 'safe' ratio across all situations.