The 4 Rules for Using Leverage in Your Finances

Read Time: 4-minutes

Happy Saturday,

Here is this week’s edition of 6-Point Saturday — financial insights to help you make smarter money decisions.

*Clickable in the online version.

Archimedes understood that leverage is a force multiplier, converting small inputs into outsized results.

In your financial life, the most recognized form of leverage is debt.

Used intentionally, debt can add real value to your life: student loans can increase your earnings power, an auto loan can quickly give you access to a vehicle to make it to work, and a mortgage can build equity over the long-term.

Used unintentionally, though, debt can produce results that range from merely stressful to catastrophic.

So, let’s look at 4 rules of thumb to help you prepare for using leverage intentionally.

Here are four places leverage shows up in your finances and how to make sure it's working for you.

Lenders use the 28/36 rule to decide how much house you can afford. This means no more than 28% of your gross monthly income on housing. And no more than 36% on all debt (e.g., student loans, auto loan, etc.) combined. Beyond these thresholds, leverage tends to work against you.

Keep in mind these rules optimize for the maximum mortgage you “qualify” for. You may have other financial goals that call for spending less, sometimes much less, on homeownership. Also, target a 20% down payment to prove to yourself that you’re financially strong and avoid mortgage insurance.

The 20/4/10 rule is a great starting guideline for financing a vehicle. It means making sure you have 20% saved for a down payment, a loan no longer than four years, and total monthly transportation costs (including payment, insurance, fuel, and maintenance) of no more than 10% of your gross monthly income.

20/4/10 helps keep your eyes from becoming bigger than your wallet when you're car shopping. And adds discipline to buying a rapidly depreciating asset.

There’s an expression that the people who “should” use credit cards are the ones who don’t need access to credit cards. In other words, only use cards when you’re in a position to easily pay them off each month.

Used correctly, credit cards can offer purchase protection, rewards, and simplicity. Used incorrectly, they're the most expensive leverage you can take on, often at 20% interest or higher. You need to be able to pay the balance in full every month or stay away from credit cards altogether.

This one doesn't show up on your net worth statement, but it might be the most underappreciated lever you have. Once you've built a strong reputation or personal brand in your field, you gain leverage to access more opportunities.

For example, a cold email from an unknown sender usually gets deleted. The same email from someone with a strong reputation gets a response. Same effort, different output. That's a form of non-financial leverage. And the earlier you build it in your career, the better.

Which of these financial areas is most relevant to you right now? What’s the next small step you can take this week to put these principles in action?

This person is stressed, worried, and regretful. That's completely understandable given what she's dealing with.

Let's look at what actually happened here.

She bought a $440k house with 10% down…that’s the first “red flag”. 20% down is the standard for good reason: it's proof to yourself that you're financially ready for the largest purchase of your life.

She's also 100% commission, with no base salary, and in recruiting, one of the more volatile industries out there. In her other comments, she mentions she’s in New Jersey, which has the highest property taxes in the nation.

Running the 28/36 rule on her best-ever salary of $169k, her housing costs land at roughly 25%. That looks fine. But use a more conservative assumption, like her prior year income of $139k, and that number jumps to 31%. Over the threshold.

Here's the thing about leverage. Used prudently, it can be a helpful tool: a mortgage on a home you can afford builds equity and stabilizes your housing costs long term. But leverage always benefits from having a margin of safety baked into your calculations.

As for what to do now: she could consider renting out a room(s) to offset the mortgage. The second job is a smart short term move, but the longer term play is transitioning into a role that includes a base salary and ideally in a more stable industry. Pure commission income and a large fixed mortgage is a combination that almost needs everything to go right.

Finally, she should get aggressive with discretionary spending—excess dining out, subscriptions, travel—and leave the Roth alone. This allows her retirement money to continue compounding tax-free while she works her way back to solid financial footing.

In 1979, psychologists Daniel Kahneman and Amos Tversky identified a pattern they called the “Planning Fallacy.” The finding was straightforward: people consistently underestimate the time, costs, and risks of future plans, even when plenty of evidence suggests they should know better.

In other words, people focus on the best case scenario and plan accordingly.

This bias can stem from focusing too much on what Kahneman called the "Inside View,” or the specific details of your own situation rather than asking how these things typically go for people in similar circumstances. That broader lens is the “Outside View.” It helps serve as a check for things like volatile commission-based income, unexpected home repairs, and cyclical industries.

Many people only run the best-case numbers on their biggest purchases. The Planning Fallacy is why it’s always worth stress testing a “middle-case” and worst-case scenario, too.

Which of these quotes resonates most with you?

Reply to let me know! I read every response.

Thanks for reading — I hope you found a helpful idea or two.

I’ll see you next Saturday with more.

Have a great weekend,

Benjamin Daniel, CFP®
Founder, Money Wisdom

P.S. Want to take control of your money, stop stressing about your expenses, & feel confident about your financial future? There are 2 ways I can help you:

Disclaimer:

This material is not investment or tax advice. No responsibility for loss occasioned to any person or corporate body acting or refraining to act as a result of reading this material can be accepted by the publisher.

👉 Is there another topic(s) you would like me to cover? If so, reply to this email & let me know—I read & respond to ALL emails.