How dangerous is LEVERAGE?

Leverage can get a bad rap, for good reason.  Excessive leverage can mean greater risk, which can lead to bad things.  But here’s how to think about it.

With a house loan, you’re getting leverage.  If you put 20% down, you’re getting $500 of house for only $100 of cash (5 to 1).  If you put 5% down, you’re getting $500 of house for only $25 of cash (20 to 1).

Is that scary?  Maybe.  But real estate doesn’t work like say, a share of stock does.  Real estate has much lower volatility (it would be rare for a house to drop 25 or 50% in value in an hour, while it’s happened plenty of times with stocks).  Also, we don’t have margin calls in real estate.  If your stock portfolio goes down a certain amount, let’s say 30%, your brokerage may call you and ask you to deposit more money or sell the stock.  Now even if the real estate market drops (which it does from time to time) no one’s forcing you to put in money or sell the home. You just need to continue to make your mortgage payments.

So here’s the key.  You never want to be a forced seller.  Make sure you have reserves so you can always make your payments.