Short answer
For an owner-occupied home, overpaying avoids interest at exactly your contractual mortgage rate and the avoided personal interest is not taxable income. An investment has to earn noticeably more than that rate before it wins, because its gain is taxed. At German capital gains rates a 3.5 percent mortgage needs roughly a 4 percent return just to draw level.Debt against growth
Is paying off the mortgage faster better than investing?
Two rates that look the same are not worth the same. One is contractual and untaxed, the other is a hope with a tax bill.| Mortgage rate | Return needed to draw level | How much more |
|---|---|---|
| 2 percent | about 2.4 percent | a fifth more |
| 3.5 percent | about 4.1 percent | a sixth more |
| 5 percent | about 5.9 percent | a fifth more |
At the German capital gains rate for an equity fund, with the yearly allowance in use. The calculator works it out for your own loan, term and tax position.
Why it is not simply the higher rate
For an owner-occupied mortgage, interest you never owe is not income, so it is not taxed. A euro of mortgage interest avoided is a euro kept. A euro of investment gain is taxed when it is realised, so it is worth less than a euro of interest avoided.
That is the whole asymmetry. Comparing the mortgage rate with the expected return directly ignores it, and the comparison comes out in favour of investing more often than it should.
One is certain and the other is not
The mortgage rate is written into a contract. The return is an assumption, and the range of outcomes around it is wide over the horizons people actually hold a mortgage for.
A break-even the market has beaten most of the time is not a promise that it will beat it over your particular twenty years. Where the two are close, the arithmetic has stopped being the deciding factor.
The overpayment limit is part of the answer
Most German fixed-rate mortgages allow an extra repayment of only a few percent of the original loan each year. Money the limit refuses does not disappear - it has to go somewhere, and the only other place is the account.
So the real choice is often not one or the other. It is the cap first, and the rest invested.
What no calculator can price
A smaller loan is a smaller fixed obligation, and that has a value to somebody whose income might change or who would not sleep through a bad decade. It does not show up in a net worth figure, and it is a legitimate reason to choose the side the arithmetic did not.