Financial leverage
Leverage means using borrowed money to fund a purchase or investment, which multiplies the effect — positive or negative — of the capital you actually put in.
Financial leverage means using borrowed capital (debt) alongside your own capital to fund a purchase or investment, in order to access an asset worth more than you could buy with savings alone. The most common example is a mortgage: buying a €200,000 home with €40,000 of your own savings and a €160,000 loan means leveraging the purchase 5 times relative to the capital you actually put in.
Leverage amplifies both gains and losses: if the asset's value rises, the return on the capital you put in is higher than if you'd bought without debt; but if the value falls, the loss is also amplified on that same capital, and you still have to keep repaying the debt with interest regardless of how the asset's value evolves. That's why leverage increases the risk of a deal at the same time as it increases its potential return.
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Frequently asked questions
What is financial leverage in a mortgage?
It's the ratio between the value of the property bought and the buyer's own capital: the smaller the initial down payment relative to the home's price, the higher the leverage of the deal.
Is leverage good or bad?
Neither on its own: it amplifies both potential gains and potential losses. It can increase an investment's return, but also its risk, since the debt must be repaid regardless of how the asset's value evolves.
Does leverage only apply to mortgages?
No, it's a general concept that applies to any purchase or investment partly financed with debt, including personal loans, buying stocks on margin, or business financing.