Should you pay off debt or invest? Compare the rates
Credit cards and personal loans cost more than equity earns, so clear them first. See the race for each loan, and which to pay off first.
6 min read
You have ₹10,000 a month spare, and some loans. Should it go into the loans, or into investments?
Short answer: compare what the loan costs with what investing can reliably earn. Paying off a loan earns its interest rate, guaranteed. Investing might earn more, but not for certain, and its gains are taxed. So expensive debt goes first, and cheap debt is a closer call.
Rule 1: compare the rates
Figure 1 from the Loan payoff calculator
What each loan costs, against what equity might earn
- Credit cardPay first36% a year
Costs more than investing is likely to earn
- Personal loan14% a year
Costs more than investing is likely to earn
- Education loan10% a year
Close to, or below, what investing might earn
- Car loan9.5% a year
Close to, or below, what investing might earn
- Home loan8.5% a year
Close to, or below, what investing might earn
- Equity funds, long run12% a year
Expected, not guaranteed, and before tax
How to read it
- 1Anything above the equity line costs more than investing is likely to earn, so paying it off is the better return. The 12% for equity is an expectation, not a promise.
Rule 2: a sure return beats a hoped-for one
Take a ₹3 L personal loan at 14% with an EMI of ₹10,300. Put the extra ₹10,000 into the loan, and it's gone in 17 months instead of 36; then the EMI and the extra both go into investments. Or invest the ₹10,000 from day one and let the loan run.
By the loan's original end date, clearing it first is ₹6.4K ahead, before any tax on the investments, and with no market risk taken. The same race for each loan, with ₹10,000 a month extra, up to the date the loan would have ended anyway:
| Loan | Rate | Runs for | Pay off first ends |
|---|---|---|---|
| Credit card | 36% | 31 months | ₹33.2K ahead |
| Personal loan | 14% | 36 months | ₹6.4K ahead |
| Education loan | 10% | 89 months | ₹28.2K behind |
| Car loan | 9.5% | 61 months | ₹28.7K behind |
Investing comes out slightly ahead against the car and education loans, but only if the market delivers 12% steadily, and before LTCG tax. Paying them off is the safer choice; splitting the extra between the two is a fair middle way.
Rule 3: which loan first?
If you're paying down several loans, the highest rate first saves the most interest. On the four loans in our loan payoff planner, ₹10,000 a month extra, highest rate first, with each closed loan's EMI rolled into the next, makes you debt-free 9.9 years sooner and saves ₹18.3 L of interest.
Figure 2 from the Loan payoff calculator
Four loans: debt-free in 7.8 years instead of 17.7
How to read it
- 1With ₹10,000 a month extra, sent to the highest rate first, the last loan is gone after 7.8 years.
- 2On EMIs alone, the home loan runs 17.7 years. Clearing the balance faster cuts the interest paid by ₹18.3 L.
Enter each loan's balance, rate and EMI. See which to clear first, when you're debt-free, and the interest you save.
Before you pay down debt
- Keep the emergency fund. Money paid into a loan is hard to get back. How many months to keep.
- Don't stop retirement saving for cheap debt. EPF and PPF contributions earn a sure 7–8%, often tax-free.
- Check for prepayment charges on fixed-rate loans. Floating-rate loans to individuals can be prepaid without charges.
What this doesn't mean
- Equity returns aren't guaranteed. 12% is a long-run average; in a bad few years investing loses this race badly.
- Tax can change it. Home-loan interest earns a deduction in the old regime, which makes that loan cheaper to keep.
- Feeling debt-free counts too. If debt keeps you up at night, paying it off has a value no table shows.
Loans repaid monthly at their own rate; investments earning 12% a year, added at the start of each month. The race runs to each loan's original end date. For illustration only, not financial advice.