Pay off a loan early or invest spare money: How to decide

If you have spare money and a loan at the same time, the question "should I pay off my loan early or invest" should not be reduced to a comparison of interest rates. Repaying a loan early gives you predictable interest savings. An investment may deliver a higher return and become part of a long term financial plan, but it always involves risk. That is why, before deciding, it is worth assessing three things together: the interest rate, the risk and the liquidity.

In short

• Expensive consumer loans are usually sensible to pay off first, because the interest savings are predictable and convincing.

• If a loan has a low interest rate, paying it off early often does not bring a significant extra benefit, so investing may be worth considering.

• Early loan repayment reduces your debt, but the money put into it is no longer easily accessible.

• Investing lets you keep your capital more accessible, but it involves risk, and its value and return are not guaranteed.

• When comparing the two options, take into account not only the rates but also taxes, your risk profile, your goals and how soon you might need the money.

Is it better to pay off a loan early or invest?

There is no universal answer. Everyone has to make the decision individually, weighing the cost of the loan, the investment risk and the availability of the money, in other words its liquidity.

Even more important than the calculations is answering two questions for yourself: "How much risk am I prepared to take?" and "How important is it to me that this money stays accessible?"

When is paying off a loan early usually the better choice?

The more expensive the loan, the stronger the arguments for paying it off faster. This applies especially to credit cards and other consumer loans with a high interest rate.

If, for example, you have credit card debt at 18% and some spare money comes in, the most logical first step will be to clear that debt.

Is there a specific rate at which a loan counts as "expensive" and should be repaid first? There is no single number, but in practice around 8 to 10% per year is often mentioned as a guideline.

The biggest advantage of paying off a loan early is that the benefit is relatively certain and predictable. The amount you actually save will, however, depend on the terms of the agreement, the remaining term and the repayment schedule. Also check whether the agreement includes a fee or other conditions for early repayment.

When would it be wiser to invest spare money?

In these situations, the logic of the decision is well described by the concept of "opportunity cost". If you use the money to pay off a loan, you give up the return it could earn elsewhere. If, on the other hand, you invest the money, you keep paying interest on the loan.

Investing could be the priority if the loan has a relatively low rate, you have already built a safety cushion and the investment horizon matches your financial goals.

This and all other calculations in this article are illustrative, gross and before tax.

Suppose you have a loan at 4% per year and 5,000 euros of spare money. If this amount is used to reduce the loan principal, in a simplified example the annual interest saving would be about 200 euros.

If the same 5,000 euros were invested through TWINO FLEXI, which currently offers a 6% fixed annual return, a simplified calculation would give an annual gross return of about 300 euros.

This does not mean investing is automatically the better choice. The difference is about 100 euros per year in favour of investing, and the capital stays more accessible, but in exchange you take on investment risk, including the possibility of losing part or all of the amount invested.

When comparing, also take taxes into account. Loan interest savings are not taxed, but investment returns usually are, so after tax the difference may be considerably smaller.

Both the actual loan interest saving and the investment result will depend on the terms of the specific agreements.

When it comes to spare money, it is worth remembering one more aspect of human behaviour. If paying off a loan frees up money that is then simply spent rather than directed towards savings or investments, putting everything into loan repayment is not always the best solution.

Which is better: investing or paying off a mortgage?

If it is a mortgage with a relatively low rate, the choice becomes even more nuanced. In this situation it matters especially how long you plan to hold the investment and how much risk you are prepared to take.

Suppose the mortgage rate is 3.5% (an illustrative assumption that does not reflect the market average). By putting 10,000 euros towards reducing the loan principal, in a simplified example the interest saving would be about 350 euros per year.

If these 10,000 euros were invested through TWINO FLEXI with a 6% fixed annual return, a simplified calculation would give about 600 euros of gross return per year.

However, these figures are not fully comparable. The loan interest saving depends on the amortisation schedule and is not taxed, while the investment is exposed to risks and its return is not guaranteed.

The overall pattern is simple: the more important access to your money is to you, the more cautious you should be about putting all your spare money into loan repayment.

On the other hand, if you have a stable income, a sufficient safety cushion and you do not like living with debt, reducing the loan can be a justified choice for both financial and psychological reasons.

If the decision is hard, you can consider a third option and combine both strategies, thereby spreading the risk. For example, put 5,000 euros towards faster loan repayment and invest the other 5,000 euros (or use a different split).

Where to invest spare money if access to it matters?

If it is not clear when the money will be needed, investment liquidity can matter even more than the interest rate.

Paying off a loan reduces your liabilities, but this process usually works in one direction only. If unexpected expenses suddenly arise, increasing the loan amount again will most likely not be easy.

So before you decide where to invest spare money, consider once more whether this money is really completely "spare". If you are not sure, solutions where you can withdraw money without waiting until the end of a term may be more suitable. How they differ from a savings account is explained in the article on fixed return and savings accounts.

The TWINO FLEXI investment solution currently offers a 6% fixed annual return and lets you withdraw funds without having to rely on the secondary market. Withdrawals do, however, depend on the product's liquidity, and in periods of high demand they may take longer.

Before deciding, it is also important to be aware of the risks associated with investing. TWINO FLEXI is not a bank deposit and is not covered by the state deposit guarantee, so it is possible to lose part or all of the amount invested.

Another nuance investors often misunderstand: a fixed return does not mean a guaranteed return, and past results do not guarantee future returns.

Before investing, read the prospectus and product terms.

How to decide in practice what to do with spare money?

There is no single correct formula, but these five steps can make the decision easier.

Check your most expensive liabilities. If you have a loan with a high interest rate, repaying it is usually the priority.

Build a safety cushion. Do not invest money you may need for an unexpected repair, a break in income or other urgent expenses.

Check when you will need the money. If in a few months, liquidity is the priority.

Compare the cost of the loan with the possible investment return. Not just the interest, but also taxes, risk and accessibility.

Consider a combined approach. Use part of your spare money to reduce the loan principal and invest part of it regularly.

Frequently asked questions

Is it better to pay off a loan faster or invest spare money?

It depends on the loan rate, the investment risk and how soon you may need the money. Expensive consumer loans are usually more worthwhile to pay off first, but with a low loan rate you can consider investing or combining both approaches.

At what interest rate is it usually recommended to pay off a loan first?

There is no single number, but in practice around 8 to 10% per year is often mentioned as a guideline. The higher the rate, the stronger the arguments for faster repayment.

Is it worth paying off a mortgage early?

With a relatively low mortgage rate, the benefit of early repayment is usually small, and the money is no longer accessible afterwards. The decision depends on your safety cushion, the stability of your income and how important it is for you to live debt free.

Can an investment return and a loan saving be compared directly?

Not fully. The loan interest saving is predictable and not taxed, while the investment return is usually taxable, exposed to risks and not guaranteed.

Is TWINO FLEXI a bank deposit?

No. TWINO FLEXI is an investment product not covered by the state deposit guarantee. There is a risk of losing part or all of the amount invested, and withdrawals depend on the product's liquidity.

Conclusion

Choosing between paying off a loan faster and investing is not just a comparison of interest rates. Early repayment gives predictable savings and reduces the psychological burden of debt. Investing lets you keep your capital more accessible and may deliver a higher return, but it always involves risk.

TWINO FLEXI could be a suitable option for those considering putting part of their spare funds into investments with a fixed annual return and flexible access.

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This material is for informational purposes and is not individual investment advice.