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Pay Off Debt vs Invest

Should I invest or eliminate debt?

About this calculator

If you have spare money each month and a debt that is not yet paid off, you can either throw the extra at the debt or keep paying the minimum and invest the difference. Paying the debt earns a guaranteed return equal to its interest rate, because every dollar of principal you clear stops costing interest. Investing earns whatever the market gives you, which can be more or less than that rate. This calculator follows both plans month by month with the same monthly budget and shows which one leaves you with a higher net worth, and by how much, at the end of the period you choose.

How to use this calculator

Enter the Debt Balance, its APR and the Minimum Monthly Payment your lender requires. Enter the Extra Money Each Month you can put toward either goal, the Expected Annual Return you assume for the investments, and the Years to Compare. Under Advanced assumptions, set the Tax Rate on Investment Gains: the default 15% is the common long-term capital gains rate, and 0% fits a Roth IRA or any account where gains will not be taxed. Every result updates as you type, and the inputs are saved in the page address so you can share or bookmark a scenario.

The method

Both strategies spend the same amount every month, the minimum plus the extra. Under Pay off debt first, the whole amount goes to the debt until it is gone, and from then on the whole amount is invested. Under Invest, only the minimum goes to the debt and the extra is invested from the first month; once the minimum alone clears the debt, the freed-up minimum is invested too. Each month the debt is charged its APR divided by 12 before the payment, and the investments grow at the annual return divided by 12 before that month's contribution is added. Net worth is the investments minus any debt still owed. The tax rate is applied only to gains, the growth above the money you put in, as if you sold everything at the end of each year shown. The break-even return is the investment return at which both strategies end exactly even; the calculator finds it by searching returns from 0% to 100%.

Worked example using the default values

A $15,000 debt at 8% with a $300 minimum, $400 of extra money a month, a 7% expected return, a 10-year horizon and a 15% tax on gains. Paying off the debt first sends $700 a month to the debt, which is gone in month 24 after $1,240 of interest; the next 96 months put $700 a month into investments. Investing pays the $300 minimum, so the debt lasts until month 62 and costs $3,307 of interest, while $400 a month is invested from the start and $700 a month after month 62. After 10 years, net worth is $87,274 paying off debt first and $86,592 investing, so paying off the debt first comes out ahead by $682. The break-even return is 8.73%: investing would need to earn more than that to win.

Interpreting the results

The comparison is driven almost entirely by the debt's APR against the return you expect. Without tax, the break-even return is exactly the APR, because a dollar sent to the debt and a dollar invested then grow at the same rate. Tax on gains lowers the investment's effective return, so the break-even rises a little above the APR, and how far depends on the horizon. In the example, a 7% return against an 8% debt loses; at a 10% return investing comes out ahead by $625 instead. The interest figures show the guaranteed part of the trade: investing first costs $2,067 more in interest in exchange for an earlier start in the market. The chart shows net worth year by year, so you can see whether one plan is ahead early and the other catches up later.

Practical tips

High-interest debt such as a credit card at 20% or more almost always favors paying the debt first, because few investments can be expected to beat that rate. Low-rate debt, such as a 3% or 4% mortgage or car loan, is where investing has a real chance. Before either, many people keep an emergency fund and contribute enough to a workplace retirement plan to collect any employer match, since a match is an immediate return that neither strategy here includes. Paying off debt is a certain return; the investment return is an assumption, so try a lower figure to see how sensitive the answer is.

Limitations

The investment return is constant every month, while real returns vary and can be negative for years, and the order of good and bad years matters. Tax is a simple rate on gains at the end; it ignores dividends taxed along the way, account contribution limits, state taxes and any deduction for the interest you pay, such as the student loan interest deduction. The debt's rate is fixed and the minimum payment does not change as the balance falls. Use the result to see which way the comparison leans and how large the gap is, not as a forecast.

Frequently Asked Questions

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