Definition
Financial leverage allows an investor to buy an asset of greater value than their personal capital, thus amplifying returns (and losses).
Concrete example: - Purchase of a duplex at $500,000 with $100,000 down payment (20%) - Mortgage: $400,000 at 5% over 25 years - Year 1: the duplex appreciates 5% → now worth $525,000 - Value gain: $25,000 - Return on down payment: $25,000 ÷ $100,000 = **25% return**
Without leverage (cash purchase at $500,000): the same 5% gain generates $25,000 ÷ $500,000 = 5% return.
Leverage also amplifies losses: - If the duplex drops 5% (-$25,000), the loss on down payment is 25% - With a mortgage, if value falls below mortgage balance → negative equity
Leverage is maximum with minimal down payment but increases liquidity risk.