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6 Things To Run Through Before Going For Maximum Leverage
Where is your comfort zone?
Lenders have a number they use to judge your financial comfort zone. They may label it with a fancy name like Total Debt Servicing Ratio and it usually fall between 30% to 50% of your monthly income. Meaning that the monthly installment that you have to pay on the mortgage should fall within the specified comfort zone ratio. Your credit score can greatly affect where exactly your limit is set.
But why do you want to leave it to the bank to determine your comfort level? You are the best person who knows intimate knowledge of where you stand financially and how much you are able to repay each month without being too taxing on your lifestyle. In order for you to make a calculated decision on an investment, you should be able to specifically define where your comfort level is.
Understand the access to leverage
Using other people’s money is not free money. The reason why there is an avenue for you to access other people’s money is that these operators rather make a smaller return on their cash than to take on a huge load of work for a bigger return. Even so, lenders may even make more profits than you because they have access to a much lower cost of funds. It can be like a supply chain where a $1 item is sold to a wholesaler for $2, which is then passed on to a distributor for $4, and then sent to a retailer for $8, and sold on the market for $15. From this example in percentage points, every player in the supply chain makes a better return compared to the retailer. If you are a clever retailer, you will know how to add value to the product to sell at $20.
As long as you can consistently make a profit out of the cost of leverage, you will be right to think that you should harness as high a leverage as you possibly can.
Where is the money?
For a lot of people, the only place they can imagine borrowing from are financial institutions and banks. But there are many more legitimate channels to get funding when a bank turns you down. The problem is that we are so conditioned to think that the bank is the only place to go for borrowings that we become skeptical of any other avenues of funding. Remember that every financier from the mega financial institutions down to the individual lender, they are just selling the same product which is cash.
Learn what lenders like to finance
Money lenders are risk-adverse. They take lesser risks compared to other businesses. They are able to operate and prosper this way by following strict guidelines passed down from the top. Even though real estate is one of the most stable assets to finance, there are also classes of real estate which banks stay away from. If you can learn what are the types of properties that banks will like to finance, you can tailor your investments to match them so that you can obtain financing more easily.
For example, completed homes are less risky than under construction homes. A 1000 square feet apartment is less risky than a 300 square feet studio apartment. A house in an upmarket district is less risky than one in an undesirable location. A $1m mass market house is less risky than a $25m luxury home.
Check out the competition
The ideal situation is that you are buying a property that is uniquely in demand in a location. And that you are the only owner that is using it for an investment purpose. If you are buying a property in a location that is already filled with landlord-owned apartments, you must do some research on the saturation of the market. Some questions to ask yourself include:
Is there strong tenant demand in the area?
How long are existing rental properties taking to find tenants?
Are properties in the area being sold by home owners or landlords?
What is the profile of tenants in the area?