The real life use of leverage
Is it better to borrow the maximum mortgage available or to limit the amount of your mortgage so that the property is cashflow positive?
Let’s take a look two real life examples of one of our clients. They were concerned that the property was cashflow negative and that they would be better to borrow only enough to make the deal cashflow positive.
Here is what I wrote in response to the client’s concerns.
OPTION 1 – BORROW LESS – CASHFLOW NEUTRAL
PROPERTY 1
Purchase Price- £189950
Mortgage for netural – £123820
Input on Completion – £38295
This will allow you make a profit each month big enough to pay for the ground rent and service charges each month.
PROPERTY 2
Purchase Price – £169950
Mortgage for neutral – £110112.35
Input on Completion – £30,946.15
PROPERTY 3
Purchase Price – £182500
Mortgage for neutral – £149,888
Input on Completion – £7062
Total input on completion for 3 properties – £76,303.15
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OPTION 2 – BORROW MORE – CASHFLOW NEGATIVE
Using the same properties as above your total input considering my 2 Year Cashflow Rule would be £19077.50 Consider this is the figure you would need to put away for the 3 properties to last you a full 2 years.
The difference between both options is – £57,225.65
If you are concerned that property won’t rise in 2 years then consider 3 years. 3 years would be £28,616 and 5 years is £47,693. I think you would agree that after 5 years the property would have increased in value enough to remortgage it and also the rents would have gone up enough to do it. This is still less that the £76,000 you are planning on putting in initially.
You could actually fully cashflow for a full 8 years for the same money. Surely after 8 years you would agree that the property would be ripe for remortgage or selling and you would have made huge money in appreciation.
This is the difference without considering how much you are losing in the additional properties that you will not be able to buy cannot buy as your capital is tied up in the existing properties.
You however may have the ability to remortgage and take out money sooner with the first option but this is unlikely due to rental figures.
Try to get your head around these figures, I know it is hard to understand how borrowing more is actually better but that is the way it works. We call this ‘Leverage’ and it is based on the prinicple of OPT/OPM or Other Peoples Time and Other People Money – You use both to your advantage to make money in life. The more OPM you have working for you the better as long as you are within your cashflows which you are well within.
Live with passion,
Brett Wood
PS. I realise this is an oversimplification of the actual maths but the principle holds true, it is the reason I always go for the biggest mortgage under any conditions, as I understand the concept of Leverage.
