Editorial Credit: StockCake.Com
When it comes to leveraging in real estate, experts often suggest leveraging high and long and paying it off gradually. However, you need to be cautious because there’s always a possibility of over-leveraging. We live in an extremely volatile and uncertain time, meaning your investment can go haywire due to a single global event.
We are heading toward a situation that resonates with the pre-2008 crash era. So, while you may want to go with 100% financing on your home loan, it comes with significant risks. In this blog, we discuss the potential risks involved in over-leveraging.
Higher Costs
Financing your real estate investments completely means you should be prepared for a significant increase in the rate of interest and fees. While the investment is an asset, you would also expect some profits in the future. However, with increased interest rates and fees, your profit percentage may be reduced.
Qualification Issues
If you intend to qualify for 100% financing on your investment, you would require a high credit score and a strong financial history. Most first-time investors are often unable to meet these stringent parameters set by lenders. Hence, they are left with limited options and often resort to high-interest unsecured lenders.
Default Risk
Lenders generally perceive that over-leveraging on an existing home loan increases the chances of loan default by the investor. If the property fails to generate the required income to make mortgage payments and other related expenses, the investor might consider selling the property at a reasonably low price or, in some cases, even face foreclosure. Such a situation can result in a financial catastrophe for the investor, ruining their credit ratings and overall reputation among investors and lenders.
Poor Investment Decisions
An investor who relies on 100% financing is likely to continue making relatively poor decisions. Since the investor has already used up their entire equity, they are likely to fall for further risky investments. This can eventually lead to negative cash flow, low profits, and failure to accomplish long-term investment goals.
Equity Risk
While you may think that the current market conditions are favorable, the future is uncertain, and housing prices can drastically fall within a few months. Therefore, 100% financing can adversely affect the equity position of the investor, especially if they are unable to manage the expenses from the income.
Limited Portfolio Growth
If the investor heavily relies on a risky option like 100% financing, the potential for portfolio growth and possible profits will reduce drastically. If you intend to increase your growth opportunities, avoid relying completely on such risky bets.
Final Thoughts
Although 100% financing is a great tool for homeowners to expand their portfolio, it is crucial to understand the risks involved in such an opportunity. Over-leveraging comes with higher interest rates and reduced profits. Therefore, you need to consider these factors to make informed financial decisions.
