May 3, 2007, 6:20 am

A leveraging strategy example

by: The Financial Blogger    Category: Leveraging Strategies
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In order to understand the full potential of an investment loan, there is nothing like some calculations. I will demonstrate what will happen if you invest on a monthly basis or if you use the same monthly cash flow to pay interest only on an investment loan.

Here are the rules: The amount of the investment loan is $50,000, interest rate is 6.5%. The monthly payment is therefore $270.83. Your investment plan is over 20 years and you think you can get an average of 8% out of the market. Finally, your marginal tax rate is 40%.

By investing $270,83 on a monthly basis over 20 years at 8%, you will get $159,524.40. During this period of time, your invested capital is $64,999.20$ for a net gain of $94,525.20. It is not so bad for the same amount as a car payment!

However, if you contracting a $50K loan over the same period with the same yield you will get… $233,047.86. By taking off the 50K debt, you will realize a pure profit of $183K. You are already making 22K more than without the leveraging strategy. But there is more!

In fact, all the interest paid on the investment loan is tax deductible. Therefore, you would receive almost 26K (so 40% of $64,999.20) in tax refund over the next twenty years. You are still not convinced, yet another little surprise.

In addition to the additional profit of 22K and the tax refund of 26K, there is one last thing I need to mention. In fact, if you calculate the growth of 8% on 159K ($12,761) and the growth on 233K ($18,643), you will notice that you will be making $5,881 more with the leverage loan than by investing by yourself. This difference will keep on increasing over time.

A lot of numbers, a lot of calculation but only one thing to remember: with the same growth, you would make more with a leverage loan. Although everything is related to the interest charged and the expected yield, you should end up with more money in your pockets. That all it matters, isn’t it?

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