All this talk about mortgages... Can you tell housing prices are slumping and people are finding themselves upside down? I hope you're not one of them. That's a hard lesson to learn.

I'm amazed at the number of conservative people I know who would never dream of buying stocks on margin, or buy calls or puts; but who think nothing at all of their struggle to make payments on their million dollar mortgages.

One day soon, if it hasn't already happened, I think many of them will realize their million dollar mortgages have them pinned to the walls of their McMansions. Their problem is the lack of greater fools. There are fewer and fewer fools out there willing to bid up home values.

The backlash has begun. We're starting to see articles like this one pop up about paying cash for a home. We'll be seeing lots more about the wisdom of paying down a mortgage too. The pendulum has swung about as far as it will go. It's stopped and is headed back to center.

It's an interesting read, the article referenced above. I know it was meant to appeal to the "in over your head" set, but it has left me wondering whether in his zeal to appeal (nice tag line, that one, eh?) he's strained his own credibility. I don't think his reporting matches his math. Check me on this. I'll be just as delighted as you if you can find my error here.

Here are his two rules for determining, with a given amount of cash to invest, whether it makes more sense to take out a mortgage and invest the balance of the nest egg; or to use the entire nest egg and pay cash for a house:

1. If the rate of return on your investments exceeds the mortgage rate, borrowing leaves you better off than paying all cash.
2. If the rate of return on your investments is less than the mortgage rate, paying all cash leaves you better off than borrowing, provided you save an amount every month equal to the mortgage payment that you would have had following a mortgage strategy.

He even gives a link to a spreadsheet to assist in doing the calculations.

Rule #1 caught my eye because it doesn't ring true to a seasoned investor like myself. I have a hard time believing it. My logic says the appreciation and value of the underlying investment - my house - won't change whether I carry a mortgage on it or not. The house simply doesn't know or care how it's being paid for. So whether I carry a mortgage or not, the impact of appreciation of the underlying asset is immaterial. The author says this, too, by the way. On this point we agree.

But where we part ways in our thinking is this business about the return rate of invested cash equaling the mortgage rate. I don't see how those two rates can be considered as canceling each other out. In terms of effective return on investment, your mortgage rate should be reduced an amount approximately equal to your marginal tax rate. That's because mortgage interest (and points, to some degree) are deductible.

And then there is the matter of basis. If you take out a mortgage, you're using leverage to gain control of an asset, which you hope will increase in value. Because you have money remaining in your bank account which you would have used (could have used) to pay cash for the house, you can further increase your potential future net worth by investing that cash.

The effect of leverage is a multiplier effect on your investment basis. Fundamentally, or so it seems to me, this has a much larger impact on future net worth than does the comparison of mortgage rate to investment return. The attached chart is one I created to illustrate the concept. The bright yellow line is computed future net worth using the power of leverage - taking out a mortgage and investing the rest of the home price. The dull yellow line is your net worth projection using no leverage - paying for your home in cash.

Did I make a mistake in my math here somewhere? You tell me. I'm pretty convinced that wisely used leverage - the kind that comes with tax advantages - is the smarter investment strategy.