Our Pay Off Debt or Invest Calculator is a tool that helps you decide whether it's financially better to use extra money to pay down existing debts or to invest it, by comparing the after-tax cost of your debt with the potential after-tax returns on investments.
This calculator helps you make the most financially advantageous decision with your extra money, potentially saving you on interest payments or growing your wealth more effectively.
Your Calculator Inputs
To get started, we only require five fields:
- Interest Rate on Debt: What current interest rate are you paying on your debt? Enter a percentage between 0 and 40%.
This amount can vary widely, depending on the debt type. For instance, credit card interest rates can be much higher than mortgage loan rates. - Is the Interest Deductible? Can you deduct the interest on your taxes? Select Yes or No.
According to the IRS, interest payments made on home loans (mortgage and home equity loans), student loans, and business loans are all tax-deductible. In addition, interest paid on money borrowed to buy investment property is tax-deductible.
Personal interest, which includes interest on credit card balances, auto loans, personal loans, late/unpaid utility bills, and late payment or underpayment of federal, state, and local income taxes, is not tax-deductible. - Before-Tax Return on Investment: What before-tax rate of return are you earning on your investment? Enter a percentage between -12% and 12%.
Remember that either a positive (meaning your asset gains value and makes money) or negative (meaning your asset declines in value and loses money) rate of return might apply. - Is the Investment Taxable? Do you pay taxes on your investment? Select Yes or No.
The IRS provides examples of taxable interest, which include interest on bank accounts (checking/savings), money market accounts, certificates of deposit (CDs), corporate bonds, and deposited insurance dividends. Interest income from Treasury bills, notes, and bonds is subject to federal income tax but is exempt from all state and local income taxes.
Refer to IRS Topic No. 409 Capital Gains and Losses for tax information on capital gains/losses after selling assets like a home, stocks, mutual funds, and bonds. - Marginal Tax Bracket: Your current tax bracket. If you answered yes to either question about whether your interest is tax-deductible or investment is taxable, enter a percentage between 0% and 75%.
Understanding Your Results
Considering any tax implications, this calculator compares your After-tax Cost of Debt with your After-tax Return on Investment to determine which path is more financially advantageous. The calculator will suggest what to do, depending on which is higher.
| Scenario | Recommendation |
|---|---|
| Cost of Debt is higher |
"It appears that you would be better off paying down debt as rapidly as possible based on your current input." |
| Return on Investment is higher |
"It appears that you would be better off investing any surplus funds while paying your minimum debt payment based on your current input." |
1. Double-Check Your Inputs for Accuracy
Before fully relying on the results, quickly review the five inputs you provided:
- Interest Rate on Debt
- Is the Interest Deductible?
- Before-Tax Return on Investment
- Is the Investment Taxable? Marginal Tax Bracket: Ensure this accurately reflects your current financial situation. An incorrect input, especially for the tax bracket or the deductibility/taxability questions, can significantly alter the outcome.
2. Identify the Calculated After-Tax Rates
- Look for a figure representing the effective interest rate you are paying on your debt after considering any tax deductions. If your debt interest is deductible (e.g., mortgage, student loan interest) and you entered your marginal tax bracket, this rate will be lower than the nominal interest rate you inputted.
- Look for a figure representing the potential return on your investment after considering any taxes. If your investment returns are taxable (e.g., interest from savings accounts, capital gains) and you entered your marginal tax bracket, this rate will be lower than the before-tax return on investment you inputted.
3. Compare the Two Key Figures
- If the after-tax return on your investment is higher than the after-tax cost of your debt, the calculator will likely suggest that investing your extra money is financially more advantageous.
- If the after-tax cost of your debt is higher than the after-tax return on your investment, the calculator will likely suggest that using your extra money to pay off debt is financially more advantageous.
4. Note the Magnitude of Difference
| Rate Difference | Implication |
|---|---|
| Small Difference | The decision is less critical from a purely numerical standpoint. |
| Large Difference | Indicates a clearer financial benefit to one option over the other. |
5. Review the Recommendation (If Provided)
The calculator may explicitly state whether paying off debt or investing is the recommended course of action based on the numbers.
6. Consider the "Why"
- If it suggests investing, it's because the numbers indicate your money has the potential to grow faster through investment (even after taxes) than the money you would save on interest by paying down debt (after tax deductions).
- If it suggests paying down debt, it's because the numbers indicate you'll get a better "guaranteed return" by saving on debt interest (after tax deductions) than you're likely to earn from investing (after taxes).
7. Remember, It's a Financial Optimization Tool
The calculator focuses on the most financially advantageous decision based on the numbers. Your personal circumstances, risk tolerance, psychological comfort with debt, and specific financial goals (e.g., needing liquidity, importance of an employer match on a 401k) are also crucial factors that this calculator may not fully encompass, but you should consider alongside its recommendation.
Final Thoughts
Deciding whether to pay off debt or invest is a personal financial choice that depends on your specific situation, including debt types (especially interest rates) and long-term goals.
Prioritizing high-interest debt, like credit cards, provides a guaranteed return and improves financial health, while investing offers the potential for higher long-term growth, essential for objectives such as retirement.
Consulting with a financial professional may help you better understand your current needs and future goals and what investments are right for you at this point in your life.
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