You have a small corpus from your past savings. Plus, you intend to save — and invest — some amount every month from your income. Congrats! That's a great way create wealth.
But, what if you could make the same money earn something extra? Wouldn't that be still better?
Well, the good news is that it's definitely possible. And, it's not difficult too. Rather, it is pretty simple. The process, by which you can make additional income from your capital, is known as Financial Leverage.
In simple terms, it is nothing but adding debt finance to your investments... to boost the returns.
Let's take a simple example to see how this works.
Suppose, you have
a) Existing investments that can be readily liquidated = Rs.10 lakhs
b) Surplus available per month for investing = Rs.65,000
c) Time frame = 5 years
Investment period = 5 years
Corpus After 5 years
a) Value of the initial corpus of Rs.10 lakhs = Rs.16 lakhs
Plus
b) Amount accumulated from monthly savings = Rs.50 lakhs
Total Equal To
Rs.66 lakhs
Rate of interest = 8.5%
Loan Tenure = 20 years
Maximum Loan possible = Rs.75 lakhs
Own Finance possible = Rs.10 lakhs (equal to existing liquid investments)
Total Property Value possible = Own Finance + Bank Finance = Rs.10 lakhs + Rs.75 lakhs = Rs.85 lakhs
Corpus After 5 years
Average property appreciation per year = 12.5% p.a.
Expected Sale Value of Property = Rs.1.52 crores
Loan Amount Outstanding after 5 years = Rs.66 lakhs
Net Corpus (after loan prepayment) = Rs.86 lakhs
Thus, under Option 2 you end up with Rs.20 lakhs extra using Financial Leverage vis-a-vis Option 1 where you invest only your own funds.
[Needless to mention: The actual gains will differ from person to person, depending on how much capital s/he has for leverage purposes.]
As you know, up to Rs.2 lakhs as interest paid on home loan is allowed as deduction for income tax purposes.
The 30% tax saved on Rs.2 lakhs would give you extra (extra) benefit of Rs.3 lakhs over 5 years. That's icing on the cake.
Yet, I have also advocated that the risk has to be managed, not avoided.
So what are the risks and how to manage them?
The BIGGEST risk is the property.
Will you be able to EASILY sell the property after 5 years? And, if so, will you get 12.5% p.a. price appreciation?
If not, the deal could possibly hurt you.
So you have to manage this risk. To ensure good price appreciation and good demand, it has to be a good property, in a good location and from a good developer.
Location, location, location. That's the key to a good property. So choose your property with utmost priority to the location.
Second, it should be a ready (or near-ready) property, so that the risk of project not being completed is eliminated or minimized.
Third, it should be relatively very new and unoccupied property. And with high quality of construction and amenities. This will ensure that it still fetches you a good price five years down the line.
In short, if you can manage the property risk, you possibly have a great deal on hand.
The other risk is... what if the loan interest rates shoot up dramatically.
Well, if you have taken care of the major risk, this one is minor.
Just sell the property, pay off the loan and close the deal. No need to continue with the loan, if the interest payout becomes unreasonably high.
So, are you ready for financial leveraging?
Warning... Financial leveraging with Equity is STRICTLY FORBIDDEN.
But, what if you could make the same money earn something extra? Wouldn't that be still better?
Well, the good news is that it's definitely possible. And, it's not difficult too. Rather, it is pretty simple. The process, by which you can make additional income from your capital, is known as Financial Leverage.
In simple terms, it is nothing but adding debt finance to your investments... to boost the returns.
Let's take a simple example to see how this works.
Suppose, you have
a) Existing investments that can be readily liquidated = Rs.10 lakhs
b) Surplus available per month for investing = Rs.65,000
c) Time frame = 5 years
Option 1: Invest the available surplus
Assumed Rate of Return = 10% p.a. (based on medium investment time-frame)Investment period = 5 years
Corpus After 5 years
a) Value of the initial corpus of Rs.10 lakhs = Rs.16 lakhs
Plus
b) Amount accumulated from monthly savings = Rs.50 lakhs
Total Equal To
Rs.66 lakhs
 |
| Give me a lever long enough... and I shall move the world. ~ Archimedes |
Option 2: Leverage the available surplus
Maximum affordable EMI = Rs.65,000 (equal to available monthly surplus)Rate of interest = 8.5%
Loan Tenure = 20 years
Maximum Loan possible = Rs.75 lakhs
Own Finance possible = Rs.10 lakhs (equal to existing liquid investments)
Total Property Value possible = Own Finance + Bank Finance = Rs.10 lakhs + Rs.75 lakhs = Rs.85 lakhs
Corpus After 5 years
Average property appreciation per year = 12.5% p.a.
Expected Sale Value of Property = Rs.1.52 crores
Loan Amount Outstanding after 5 years = Rs.66 lakhs
Net Corpus (after loan prepayment) = Rs.86 lakhs
Thus, under Option 2 you end up with Rs.20 lakhs extra using Financial Leverage vis-a-vis Option 1 where you invest only your own funds.
[Needless to mention: The actual gains will differ from person to person, depending on how much capital s/he has for leverage purposes.]
The Bonus
So far, I haven't considered the tax deduction on the interest paid.As you know, up to Rs.2 lakhs as interest paid on home loan is allowed as deduction for income tax purposes.
The 30% tax saved on Rs.2 lakhs would give you extra (extra) benefit of Rs.3 lakhs over 5 years. That's icing on the cake.
Are there any risks?
Of course. As I have often warned, no investment is risk free.Yet, I have also advocated that the risk has to be managed, not avoided.
So what are the risks and how to manage them?
The BIGGEST risk is the property.
Will you be able to EASILY sell the property after 5 years? And, if so, will you get 12.5% p.a. price appreciation?
If not, the deal could possibly hurt you.
So you have to manage this risk. To ensure good price appreciation and good demand, it has to be a good property, in a good location and from a good developer.
Location, location, location. That's the key to a good property. So choose your property with utmost priority to the location.
Second, it should be a ready (or near-ready) property, so that the risk of project not being completed is eliminated or minimized.
Third, it should be relatively very new and unoccupied property. And with high quality of construction and amenities. This will ensure that it still fetches you a good price five years down the line.
In short, if you can manage the property risk, you possibly have a great deal on hand.
The other risk is... what if the loan interest rates shoot up dramatically.
Well, if you have taken care of the major risk, this one is minor.
Just sell the property, pay off the loan and close the deal. No need to continue with the loan, if the interest payout becomes unreasonably high.
So, are you ready for financial leveraging?
Warning... Financial leveraging with Equity is STRICTLY FORBIDDEN.
