What does leverage in finance refer to?

Leverage in finance specifically refers to the use of borrowed funds to amplify potential returns on an investment. This strategy allows investors to invest a larger amount of capital than they currently possess by borrowing money, which can lead to higher profits when the investment performs well. By leveraging their investments, individuals or companies can control more assets and increase their earnings potential without needing to raise equivalent equity.

For example, if an investor uses a combination of personal funds and borrowed money to purchase real estate, any appreciation in the value of that property can result in a significantly larger percentage gain relative to the investor’s original cash outlay. This use of debt increases both potential returns and risk, as leveraging also means that losses can be amplified if the investment does not perform as expected.