Economic terms and conditions can be confusing to those who have not studied and/or used it in their every day lives. The study of economics is an intricate one, yet one that affects every one’s lives on a daily basis.
Have you ever heard someone say, “I’m 100% leveraged in my home,” and wondered what exactly they were talking about?
According to the Merriam-Webster dictionary, leverage is the use of credit to enhance one’s speculative capacity. In other words, it is the act of borrowing money, for example, to increase one’s portfolio.
Think of an actual lever. A small handle or crank is used to control a larger portion of the actual machine. The same is true with financial leverage. A small amount of money is used as a down payment of sorts. That small amount of money controls a larger loan amount.
Let’s look at a small example.
The real estate market has been struggling for some time now. Home owners all over the country have lost equity in their properties. Although it has hurt these owners by taking a portion of their equity, it has created an ideal buying market for potential buyers. These buyers are able to get ‘more home for their money’ because the value of every American home has decreased.
Often times, these buyers need help finding the resources needed for closing costs and down payments. There are different programs in place that allow potential buyers the opportunity to borrow 100% of the mortgage. Thus, they are not required to put down the traditional 20% down payment.
Home owners who have borrowed 100% of their mortgage are 100% leveraged in their home no matter if they used a traditional home loan, or something like a va loan. They have come up with a small amount of money for closing costs and borrowed the full amount of the mortgage. Individual buyers who put the traditional 20% down when purchasing a home and borrow the remaining 80% are 80% leveraged in their homes.
When broken down and defined, economic terms are not as complicated. Economic leverage is a simple theory that can become more complicated as it is used in more complicated ways.
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