Invest or Pay Off Debt: Which Is More Profitable?
To invest or to pay off debt — the question of the ages. You might think the answer is obvious, but you need to dig a little deeper. Here's how to actually decide.
To invest or to pay off debt — the question of the ages. You might think the answer is pretty obvious, but on the contrary, you need to dig a little deeper. Like any other financial question, it really all depends on your own financial picture.
Here’s the simple answer. If your investments earn more than the interest you’re paying on your debt, then it makes sense to invest. However, if you have high-interest debt such as credit cards, then it almost always makes more sense to pay off that debt first — paying off a card charging 22% is a guaranteed 22% return, and nothing in the market reliably beats that.
It’s a little more complicated than that, though. Let’s dig in and figure out whether you should invest or pay off your debt.
Is it good debt, or bad debt?
First things first. It’s important to determine whether your debt is good debt or bad debt. Good debt is debt that makes you more money. For example, having a mortgage on a rental property is good debt. It only counts if you’re making a profit off of it greater than the interest being charged.
On the other hand, bad debt is debt that doesn’t make you any money. Personal loans, car loans, credit card debt, and payday loans are all forms of bad debt. This type of debt severely slows down your path to financial freedom. If you have bad debts, it’s probably a good idea to pay those off completely before doing any investing. You can see exactly how much that debt is costing you with the debt-to-income calculator and the car payment calculator, and our guide to escaping debt and credit card tips lay out how to attack it. In this case, you’d rather pay off debt than invest.
What about a mortgage?
All right, what if you have a mortgage? This is where the math has shifted a lot in recent years. For most of the 2010s, mortgage rates sat at historic lows — often 3 to 4% on a 30-year loan — which was genuinely cheap money. Back then it made little sense to pay it off early; you were almost always better off investing the difference.
That picture has changed. Mortgage rates climbed sharply and have been hovering around 6.49% on a 30-year loan. That changes the calculus. The deciding number is the gap between your mortgage rate and what you can reasonably expect to earn investing. At a 3% rate, that gap was wide, so investing won easily. At ~6.49%, paying down the mortgage is a guaranteed, risk-free ~6.49% return — which is right in the range of what stocks have historically returned, but without the risk or the volatility.
So the honest answer today is “it depends on your rate.” If you locked in a low rate years ago, keep it and invest the difference. If you’re carrying a newer, higher-rate mortgage, paying it down is far more attractive than it used to be. Either way, contribute to retirement first (more on that below), then weigh extra mortgage payments against investing — and remember those market returns aren’t guaranteed and get eaten into by inflation.
Student Loans
Student loans typically have relatively low interest rates. This might mean you could potentially earn a higher return investing than you’d save by paying off your student loans first. There’s a big caveat, though.
Although student loans might have a lower interest rate than credit cards, this is still considered bad debt. Student loans don’t make you money, they often come with a hefty monthly payment, and you can feel stuck with them for what seems like forever. Because of this, it can make a lot of sense to pay off your student loans first. Doing so frees up a lot of cash flow once they’re gone, which you can then redirect into investing.
Read Next: Top 10 Ways To Pay Off Your Student Loans Fast
Calculate your DTI ratio
Your debt-to-income ratio is an excellent indicator of how much debt you’re carrying compared to your income. The formula is pretty simple: divide all your monthly debt obligations by your monthly gross income.
Once you figure out your debt-to-income ratio, you’ll have a clear picture of how deep in debt you’re swimming. The debt-to-income calculator does it for you in seconds and shows where lenders place you. If your DTI is creeping high, that’s a strong signal to prioritize paying off debt before you ramp up investing.
Can you pay off debt and invest at the same time?
Yes — and it’s probably a better idea to do both! How, you may ask? By investing in a company-provided 401(k)!
No matter what your strategy is, investing for your retirement is paramount. If your employer offers a 401(k), always make sure you contribute to it without fail. If they offer a company match, then make sure you contribute enough to get the full match! It’s free money, and it’s your retirement fund, so do whatever it takes to capture it. Always. (Not sure how much you should have? Start with how much you should have in your 401k.) Grabbing the match should come before extra debt payments — there’s no debt payoff that beats an instant 100% return from a match.
Final thoughts
When deciding whether to invest or pay off debt, the order of operations is usually: capture the 401(k) match first, then wipe out high-interest (bad) debt, then invest the rest. High-interest debt almost always wins the “pay it off first” argument — every time.
The classic exception was a low-rate mortgage, where you were nearly guaranteed to make more elsewhere. But with today’s higher rates, even that exception is closer than it used to be, so run your own numbers: compare your interest rate to your expected return, and let the bigger one win. Food for thought.
