Today, let’s talk about something that can help you grow your wealth and achieve financial freedom – leverage.

When you hear the word “leverage,” you might think it’s something only property owners can use. But leverage is a powerful tool that can help you grow wealth in many ways, even if you don’t own a home.

We’ve all heard our parents tell us that debt is bad. But the truth is, when used wisely, debt can be a game-changer. That’s where leverage comes in – it’s the key to unlocking your financial potential and helping you achieve your goals faster than you ever thought possible.

But before diving in, it’s worth understanding the difference between good and bad debt. Knowing those differences will better equip you to use debt to your advantage and avoid potential pitfalls.

Good debt vs bad debt

Good debt is any debt that can help you build wealth or improve your financial situation over time. This could include a mortgage for a home or student loans that help you increase your earning potential.

Bad debt, on the other hand, is debt that can harm your financial health. This could include credit card debt or high-interest personal loans to fund non-essential purchases. These debts can quickly pile up and become difficult to pay off, causing financial stress and potentially harming your credit score.

While good debt can be a valuable tool for building wealth and achieving financial goals, it’s important to remember that everyone’s financial situation is unique. What may be considered good or bad debt for one person may not be the same for another.

Unfortunately, many Australians stunt their financial growth by getting into bad debt, often leading to the idea that you should avoid all debt. But don’t let this blind you from the benefits of good debt in the form of leverage.

So, what is leverage?

Leverage or ‘gearing’ is a way to borrow money to make investments, but it’s not for the faint of heart. While it can lead to higher returns during good times, it can also increase your losses when the market drops. Remember that even if your investment loses value, you’ll still have to repay the loan with interest.

Let’s say you have $10,000 saved and want to invest in the stock market. You could use that money to buy a few shares, but your potential gains would be limited to how much those shares increase in value. But what if you could borrow another $10,000 to add to your investment? You’d have $20,000 to invest, allowing you to buy more shares and make more money if those shares increase in value.

However, leveraging is not for everyone. It’s a high-risk approach better suited for experienced investors, so consider speaking to a financial advisor first.

So how does financial leveraging work for renters?

If you’re a renter looking to build wealth over the long term, financial leveraging might be a strategy worth considering, but it’s worth understanding the risks involved.

Investing in exchange-traded funds (ETFs) is one way to leverage your finances. These funds track various assets, from stocks to bonds and more, exposing you to a diversified investment portfolio without purchasing each asset individually. This can reduce your risk by spreading your money across a range of investments.

Another option for leveraging your finances is peer-to-peer (P2P) lending. P2P platforms connect lenders with borrowers, allowing you to earn interest on your investment. The potential returns can be higher than those offered by traditional banks, making it a tempting option for those looking to diversify their portfolios.

If you’re feeling daring, consider margin trading. This strategy involves borrowing money to purchase securities like stocks or ETFs, potentially amplifying your returns. However, it’s a high-risk approach that should only be attempted by experienced investors.

Remember, financial leveraging is a long-term strategy that carries significant risks. Before jumping in, it’s always a good idea to speak to a financial advisor and ensure it’s the right approach.

Build your credit score with RentPay Scorebuilder

Boost your credit score and make it easier to borrow money for investments! With RentPay’s Scorebuilder feature, you can build a stronger credit score. It’s an essential component of financial leverage because a higher credit score can lead to better loan terms and lower interest rates.

Here’s the deal: Every month you keep an open Scorebuilder line of credit, we’ll report your account status to Equifax, one of Australia’s largest credit reporting bodies. Even if you don’t draw from it, we’ll keep track of your progress. And if you’re good about paying back what you borrow (or not borrowing anything at all), your credit score could improve.

It’s simple, really. A higher credit score makes you a more attractive borrower to lenders, meaning better loan terms and lower interest rates.

What risks are at play?

Let’s talk about the risks involved in leveraging. ASIC’s MoneySmart website outlines four main risks you should be aware of before making any big moves.

Firstly, there’s investment income risk. This means that the income you receive from your investment may be lower than you expect, or you may not receive any income at all. Make sure you have a plan to cover your living costs and loan repayments if this happens.

Next up is interest rate risk. If you have a variable-rate loan, the interest rate and your interest payments can increase over time. Could you still afford your repayments if interest rates increased by 2% or 4%?

Another risk to keep in mind is bigger losses. When you borrow money to invest, you increase the amount you could lose if your investments don’t perform well. Remember, you still need to repay your loan and interest regardless of how your investment goes.

Lastly, there’s capital risk. This means that the value of your investment could go down. If you need to sell your investment quickly, it may not cover your loan balance. Be aware of this risk and have a plan in place to manage it.

How to be smart with leverage and minimise your risk

Are you thinking about leveraging to grow your wealth? Before you dive in, it’s crucial to minimise your risks. Here are some tips to help you protect yourself:

  • Diversify your investments: Don’t put all your eggs in one basket! Diversification will help protect you if a single company or investment drops in value.
  • Borrow less than the maximum: Sure, lenders may offer you a huge loan amount, but that doesn’t mean you should take it. The more you borrow, the bigger your potential losses and interest repayments. So, think carefully about how much you need to borrow and stick to a lower amount.
  • Build up an emergency fund: Unexpected costs can pop up at any time, so make sure you have a cash buffer set aside. Aim for three months’ worth of rent to protect yourself. More on emergency funds here.
  • Pay the interest: Don’t let your loan and interest payments spiral out of control! Making interest repayments will prevent them from getting bigger each month.
  • Shop around for the best investment loan: Don’t just settle for the first loan your lender or trading platform offers you. You could save a lot in interest or fees or find a loan with better features. Shop around to find the best deal for you.

By following these tips, you can be smart with your leverage and minimise your risk.

Please note that this article is for informational purposes only and is not intended to provide any financial advice. The information provided in this article is general and may not be suitable for your circumstances. Seek professional financial advice before making any financial decisions.