If you’re not financially literate, the concepts of leverage and credit can be confusing.
They may seem similar, but they are actually two different things.
In this post, we’ll explain the differences between leverage and credit, and give you some simple analogies and examples to help you understand.
What is leverage?
Leverage is the use of borrowed money to increase your potential returns.
It’s like using a lever to lift a heavy object – the lever magnifies your strength, allowing you to lift more than you could on your own.
Similarly, leverage magnifies your investment returns, allowing you to earn more money than you could with just your own capital.
For example, let’s say you want to buy a rental property. You don’t have enough money to buy the property outright, so you take out a mortgage.
By using leverage, you’re able to buy the property and potentially earn a return on your investment that is greater than if you had used only your own money.
What is credit?
Credit is the ability to borrow money.
It’s like having a credit card that you can use to make purchases, and then pay back the money later.
Credit can be used to buy things you can’t afford to pay for all at once, like a car or a house. It can also be used to cover unexpected expenses, like a medical bill or car repair.
For example, let’s say your car breaks down and you need to get it fixed.
You don’t have enough money in your bank account to pay for the repair, so you use a credit card to pay for it. You then pay back the credit card company over time, usually with interest.
What’s the difference between leverage and credit?
While both leverage and credit involve borrowing money, there are some key differences between the two.
The main difference is that leverage is specifically used to increase your potential returns.
You borrow money to make an investment that you hope will earn you a profit.
Credit, on the other hand, is used to make purchases or cover expenses that you couldn’t otherwise afford.
Another difference is that leverage is usually associated with investments, while credit can be used for a variety of purposes.
For example, you can use credit to buy a car, pay for college tuition, or cover unexpected expenses.
Lastly, leverage can be riskier than credit because it involves investing with borrowed money.
If your investment doesn’t perform as well as you hoped, you could lose not only your own money but also the borrowed money.
Credit, on the other hand, is generally considered less risky because you’re not investing the borrowed money, but rather using it to make purchases or cover expenses.
In the end, while leverage and credit may seem similar at first glance, they are actually two different concepts.
Leverage is used to increase your potential returns on investments, while credit is used to make purchases or cover expenses that you couldn’t otherwise afford.
Understanding the differences between these two concepts can help you make informed financial decisions and avoid unnecessary risk.
