Question

 

Leverage can also impact you in your personal life. Explain how you can use it to your advantage.

        Leverage can be useful in life. For example, using a credit. It gives you the opportunity to buy things now and pay later. It allows people to buy more things and save their cashflow. However, it does come at this risk of defaulting on minimum payments and causing interest on those missed payments. It will also increase the amount of debt you have. Leverage in my personal life can be great if used with good judgement and financial moves. It is always good to be cautious when using financial leverage to avoid unnecessary risk.

Answer 1

Leverage in personal life means basically including debt in sources of funds for your expenses.

Debt can be in many forms

long term - like home loan, car loan, personal loan etc

short term - like credit cards,

Benefits in using debt in personal

1. for eg buying a home with home loan will allow to own a asset without actually paying for it fully.

illustration. say you buy a home worth 10000000 which is funded with 20% of your own contribuiton 80% funded by home loan at 10% pa interest rate. The emi for the same would be about 80000 per month and about 950000 per year. which will include 800000 interest and balance 150000 as principal repayment. The principal repayment amount gradually increases and interest reduces.

Lets assume over period of 5 years, you may repay 800000 principal amount. and thus 7200000 is balance principal to be paid.

Over period of 5 years, lets say the house value appreciates by 10% per year to about 16100000.

If you sell the same you get 16100000-7200000 = 8900000

You have paid 950000*5 = 4750000 as loan interest & principal

so net residual = 8900000-4750000 = 4150000

Thus you have earned 4150000 on your investment of 2000000 which is more than 100% returns over 5 years, whereas the actual value of asset has just increased to 60% over 5 years.

Similar is the case with Credit card

Whenever you purchase using credit card, you postpone your cashoutflow.

Illustration - say you purchase an item costing 1000 using credit card. You get atleast one month credit period aftr you have to pay credit card outstanding amount. So you have 1000 to use for one month, which even if invested in safe givt securities can earn upto 0.8-1% per month thus you will earn 10 more by delaying your cash outflow using credit card

Cautions

Having said the benefits of using debt, the debt obligations should always be timely met as and when due, else the penal interest can be very high eroding your asset value, and consume your savings.

Penal interest for home loans is about 2% pa and for credit cards is about 3.5-4%

Hence using debt in your personal life with propoer planning to service the debt obligations is healthy way to grow your hard earned money