Pay Down vs Invest

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I currently have enough money to pay down 65% of a California townhome I plan to live in, but that money could easily buy several investment properites in other parts of the country.

My uncle is a real estate agent who owns a property management company. He told me if I decided to buy property in his area he could put me in contact with a birddog and set me up with some nice investment property.

My question is, should I go ahead and pay down my house or buy rental property and let that pay my mortgage?

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Anyone have any comments on this article? I just finished it, and I have to say it reads like an advertisement for a mortgage company. At first blush, I have some problems with some of his assumptions. First, he talks about "risk free" but then ignores the risks involved with "Brother B"'s investments (which, apparently, make 8% a year). 8% not unrealistic, but it's certainly not guaranteed or risk-free, especially over the short term such as the 5 years before the hypothetical job loss.

There also seems to be some finagling with the tax savings calculations (which result in a lot of "Brother B"'s money to invest). First, the author seems to pretend like the standard deduction doesn't exist and that "Brother A" would continue to itemize deductions even though he would have less tax owed under the standard deduction (I think it's $10K/year for a couple, but I'm not sure). Worse, though, is how the author calculates the tax savings over the course of the entire loan and then averages it over that time, and uses the difference of this average as an amount Brother B can invest every year. This gives a much greater (and unreal) cash advantage to Brother B earlier than he would actually have it, and thus gives him more investment return than he would really get.

Let's assume Brother A (whose interest payments never exceed the standard deduction) instead chooses not to itemize but to take the standard deduction every year. Brother B's only tax savings is the amount above the standard deduction that he paid in interest. In reality he's only saving $109/month in taxes (for 15 years). Add that to the lower monthly payment and you get a net after-taxes difference in mortgage payment of $317/month (not $428).

So, what does this get you? Remember, he's getting 8% return, but we have to assume that he means before taxes. Presumably he's paying captial gains tax on this investment. Say capital gains is 25%, so he's really only getting 6% after tax return. Thus, in 15 years, Brother B's extra $317/month will be worth $92,189 and his original $30K will be worth $73,622, for a total of $165,812. He has paid off only the initial $10K of his house (it was interest only for the first 15 years). Brother A, of course, has paid off his entire house. After 15 years, Brother A's net assets are $200K (the value of the house) and Brother B's net assets are $175K. But I bet his mortgage broker got a pretty sum.

Now, it's at 15 years, Brother B still owes his mortgage and will be paying on it for the next 15 years. Brother A, who already has higher net assets, will have no debt obligations and can invest every dime that Brother B will be paying in interest and principal for the next 15 years. He will skyrocket way out of the reach of Brother B in terms of assets.

I've discarded the spurious distraction of Brother A paying an additional $100K/month on the mortgage and Brother B investing an extra $100K/month just to show what the real difference is between paying off your mortgage vs. borrowing on your house to invest. All of this also assumes that Brother B really did get his 8% return.

I also disagree with two over-riding points:

(1) I don't agree that most Americans are trying to own their home outright. If anything, Americans are more in debt (including their homes) than at any time in history (I can't back that up, but I think it's correct).
(2) I don't believe him when he says that paying off your mortgage puts you at greater risk of foreclosure. It certainly seems to me that all the evidence points to the opposite. Again, I can't back this up, but I would love to hear others' opinions on this subject.

I'll confess that these numbers (especially the standard deduction and the tax rates) are off the top of my head, and these are quick calculations. Also, taking the standard deduction also gives up savings in RE taxes and other deductions, but also note that the standard deduction has increased recently and any additional increase over the next 15 years would be to the advantage of Brother A. I'd like to hear what others think about this.

I guess my bottom line is:
(1) I still think it's better to pay off the mortgage
(2) The standard deduction is the dirtly little secret the mortgage-lovers tend to ignore when they do their calculations and
(3) Don't forget to look at the "after tax" return on the invested difference.