Pay down debt or invest

Paying down debt gives you a guaranteed, tax-free return equal to the loan's interest rate. Investing gives you an uncertain return, minus tax. See which side wins with your own numbers.

How this is calculated

What it calculates

Whether an amount you have available does more for you when you use it to pay down a loan or when you invest it. Over a given period and after tax.

Your inputs

Amount available: the money you are deciding about.
Effective interest rate on your debt: what the debt costs you per year.
Assumed investment return: an assumption, not a promise.
Tax on investment income: deducted from the investment return.
Time horizon: in years.

The calculation

Both sides are calculated with annual compounding over the same period:

Saving from paying down debt = amount × ((1 + loan rate)^years − 1)
Investment return before tax = amount × ((1 + return)^years − 1)
Return after tax = return before tax × (1 − tax rate)
Advantage = difference between the two

Assumptions: the interest saved is calculated as if the repaid amount would otherwise keep compounding for the whole period. Tax is deducted once from the total return, with no allowance. Interest you save on a loan is tax-free, so nothing is deducted on that side. If investing comes out ahead by less than 15% of the larger value, the calculator flags the result as close.

What the result means

The saving from paying down debt is certain; the investment return is only an assumption. A calculated lead for investing therefore needs to be clear to justify the extra risk.

Example

Default values: €5,000, a loan at 8%, an investment with an assumed 7%, 26.4% tax, 10 years. Paying down saves €5,000 × (1.08¹⁰ − 1) ≈ €5,795. Investing earns €5,000 × (1.07¹⁰ − 1) ≈ €4,836 before tax, about €3,559 after tax. Advantage for paying down debt: €2,236.

The investment return is an assumption; the interest saving isn't. So when the result is close, that favors paying down debt.

The full explanation is in the lesson Expensive debt first.

Frequently asked questions

Why can't a debt payoff's return be compared directly to an investment return?

Because it's guaranteed and tax-free, while an investment return is uncertain and taxable.

What gross return would an investment need to beat an 8 percent loan?

With about 26 percent tax on investment income, roughly 10.9 percent, and it would have to be certain too. 8 divided by 0.736 gives just under 10.9.