Should I use 30 yr or 15 yr loan for my rental properties?

[Libby Baugher]

I have a question regarding which loan to use for my rental properties. Here is some background on me. 

I am 51 years old and am just beginning my real estate portfolio. I have a good paying, secure job making 6 figures and I don't spend much money. I have a mortgage payment on my house (15 yr loan) and have 12 more years to pay it off. My goal is to get between 3000 to 5000 monthly passive cash flow within 5-7 years. I've looked at turnkey investing and local investing and have decided to start with local investing because I will get higher cash flow doing local. I have a friend who is realtor and she is quite knowledgable about real estate investing and in fact finds homes for investors, brings contractors in to do rehabs and has a team that does property management. 

I have just gotten an appraisal on my primary home and am waiting the results although it should come in around 60000-70000 to use as HELOC. I also have a non retirement account worth about 65000 that I have set up so that it is attached to my checking account if I need it for anything real estate related. In addition, I have a 401k worth around 65000 but am not sure I will use that for real estate. I have other retirement accounts that I won't be using as I don't want to be taxed when I withdraw money from them.

My hometown bank gives a maximum 4 mortgages per person and I've already used one up for my primary so I have three mortgages left with them. I'll obviously need to find other ways to purchase more properties. 

The price range for my purchases will be between 40000 and 80000 (I live in central Illinois) and I've noticed some homes in this range are already rehabbed and some need rehabbing. I look at both groups. Between the realtor and friends who live in the city I'll be purchasing in, they can help me to determine good neighborhoods....I'll be able to determine this too as I grew up in a small town right outside of the city I'm purchasing in. 

Anyway my question is this.....due to my age at starting out, I'm wondering if I should use 30 year loans or 15 year loans. I can understand if I was 20 to 30 years younger I would be using 30 year loans all the way. But now that I'm older and hoping to retire within 7-10 years, I'm wondering if I should use 15 year loans and get the houses paid off and then have full cash flow from all the homes. This would also help with not having to purchase so many homes before I retire as I would get that full amount of monthly cash flow for each home. I figure I'll need at least 10-15 homes to get to my monthly cash flow goal but I see two different methods to attain this.....get the homes paid off (fewer purchases and I'll be helping to pay off the loan) or use 30 year loans (more purchases but I will not be helping to pay off the loan). 

Any thoughts and advice would be great!

Libby

[Bill F.]

@Thomas S. Thanks for taking the time to respond to my question. 

I get the theory and see where you get the 2:1 ratio, but I have some issues with the math. 

1. If we call investing at 10% the opportunity return and paying the mortgage (5%) real return, due to the time value of money formula having five variables (Present Value, Future Value, rate, number of periods, and payment) the ratio of opportunity to true return cannot stay constant at 2:1. The closer the interest rate is to the opportunity rate and shorter the period of time, the lower the ratio, due to compounding interest. 

For example. If we take $100 payment and the Opportunity rate (10%) and mortgage rate (5%) and compound them over 15 periods, the future values (FV) are:

FV Opportunity= $3,177 and FV True=$2,158 or a ratio of 1.4: 1

If we change only the true rate to 7.5% the ratio drops to 1.2: 1

To get a ratio of 2: 1 in this period the Opportunity rate has to be 11.5% and the true rate 2.5%. 

If you change the period to 20 and keep the rates at 10% and 5% the ratio goes up to 1.7: 1. 

So like @Joe Splitrock pointed out, the difference between the mortgage rate and the opportunity rate is what drives the investment decision along with how long you hold the asset. 

Simple single period calculations like ROI can't capture the impacts that compounding has on an investment. That is where Discounted Cash Flow, IRR, MIRR, come in to play.