Extra repayment or investing: understanding the break-even return
What net investment return would be needed to beat an additional loan repayment?
A spare amount can reduce outstanding debt or remain invested. The choice depends on more than an expected investment rate: access, fees and the reliability of returns must be part of the same comparison.
Check the right to repay first
A contractual overpayment allowance is not the same as unrestricted early termination of a loan. Whether an additional payment is possible and what it costs depends on the loan and its terms. Section 500 of Germany’s BGB distinguishes, among other things, conditions applying to mortgage consumer loans. Check amount, timing and possible compensation before assuming repayment is free.
A deliberately simple one-year comparison
Illustrative assumptions: €5,000 less outstanding debt avoids €200 interest at 4% over a full year, if the difference between the compared debt balances otherwise stays unchanged. Investing €5,000 at 5% initially earns €250. With a charge of 25% on the entire return assumed solely for this example, €187.50 remains. Before any other costs, that is below the €200 saved.
Calculate the break-even point
In the simplified comparison, gross return r must satisfy r × (1 − t) > d: t is the assumed charge on investment income and d the avoided borrowing rate. With d = 4% and t = 25%, the threshold is about 5.3333%. This is not a statutory tax calculation. Allowances, loss offsets, fees and different payment dates can change the individual comparison.
Equal returns do not imply equal risk
An expected securities return is not a promised interest payment. Compare repayment with a loss scenario as well as an average return. Extra repayment also ties up liquidity: the money usually cannot simply be withdrawn again. An adequate reserve may matter more than a small calculated return advantage.
Use the repayment schedule over multiple years
For an amortising loan, the difference in outstanding balances changes over time; the simple annual comparison is only a guide. Calculate both payment schedules to the same end date and include what happens to instalments saved. Compare outstanding debt and available investment assets together. Otherwise, faster debt reduction can misleadingly appear to produce a worse financial position.
The numerical hurdle is a comparable net return after costs. A decision also needs the risk, reserve and actual repayment rights to be considered.