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Leverage
Leverage is borrowing to purchase an asset so that while you have control of the asset you have not as of yet paid the full purchase price of that asset. Leverage is commonly used in property investment. The net effect of leveraging is to multiply the possible return, and also multiply the risk run by the investor. Without borrowing someone with $20000 could only own $20000 of assets. If they borrowed to 80% of the value of the property they could own $100000 of assets for the same initial investment of $20000. This means that if values go up by 10% they would earn $10000 rather than $2000. However conversely they would also lose $10000 rather than $2000 if values went down by 10%.
In the field of property investment leverage (also known as gearing) is commonly expressed in terms of the Loan To Value Ratio (LVR). Which can be expressed as a percentage: L/V
So for example if the loan was $80000 and the property's value was $100000 then the LVR would be 80000/100000 = 80% so the property would be described as leveraged or geared at 80%.
Residential Leverage
Traditionally residental lenders have liked investors to have a maximum LVR of 80% whereby the lender will fund up to 80% of the purchase price or value of the property.
There are now lending products that allow the investor to borrow up to 100% of the value of a property, however such lending products usually require Lenders Mortgage Insurance which is an additional cost the investor must pay.
The degree to which an investor leverages themselves is determined by the investor's risk tolerance, and the stage of the property cycle. During the recovery and boom phases of the property cycle some investors are prepared to leverage themselves highly (e.g. 90% or higher) in order to take advantage of increasing property values. During the slump stage many investors aim for low leverage (e.g. 65% or less) in order to prortect themselves during a downturn in the market.
