Pay Off the Car Loan or Invest? The Rate Is the Whole Answer
2026-09-18
Short answer: Paying off a loan earns exactly its interest rate, guaranteed and after tax. On $18,000 left at 7.5% over 36 months, clearing it and investing the freed $559.91 payment ends at $21,861; investing the $18,000 instead and keeping the payments ends at $21,136. The loan wins by $725 because 7.5% guaranteed beats 5.5% expected — and the comparison flips only when the expected return exceeds the loan rate.
The principle
Paying off a loan is an investment. The return is the loan’s interest rate, it is guaranteed, and it is not taxed. That makes it directly comparable to an investment only after you have put both on the same basis: guaranteed and after tax.
A loan at 7.5% therefore competes with an investment that returns more than 7.5% after tax, with certainty. Almost nothing does.
The arithmetic
Both options must use the same money and the same monthly cash flow, or the comparison is rigged. Here they do.
Worked example — 18,000 left on a car loan at 7.5% with 36 months to run, a 559.91 monthly payment, and $18,000 of cash available. Assume a 5.5% after-tax expected return.
Option A — pay the loan off, then invest the freed payment.
| Step | Result |
|---|---|
| Cash spent now | $18,000 |
| Monthly payment freed | $559.91 |
| Invested monthly for 36 months at 5.5% | $21,861 |
Option B — invest the cash, keep paying the loan.
| Step | Result |
|---|---|
| $18,000 invested for 36 months at 5.5% | $21,136 |
| Loan paid from income as before | (same outflow as A) |
| Position at month 36 | $21,136 |
Option A is $725 ahead, and it got there without market risk. The reason is not complicated: 7.5% guaranteed is more than 5.5% expected.
Paying off also avoids 2,156.76 of remaining interest — that figure is the same 725 advantage viewed from the other end, net of what Option B’s investment earned.
Where the line sits
The break-even is exactly the loan rate. If your expected after-tax return exceeds 7.5%, Option B wins on expected value while carrying risk that Option A does not. If it is below, Option A wins outright.
That produces a practical ordering:
| Rate | Action |
|---|---|
| Above ~8% (credit cards at 24%) | Clear it. Nothing liquid competes. |
| 5-8% (typical car loans) | Close call. Paying off wins on a risk-adjusted basis. |
| Below ~4% (subsidised or 0% finance) | Keep it. Cash earns more in a savings account. |
What the arithmetic does not price
Liquidity. 18,000 in a savings account can pay for a job loss. The same 18,000 as equity in a car cannot, without selling the car. This is the strongest argument for Option B and it has nothing to do with returns.
Order of operations. Before either option: capture any employer retirement match, which is an immediate 50-100% return and beats both; and hold an emergency fund, because a cleared car loan does not help in the month the income stops.
Your own payoff quote. Ask for it rather than using the balance. Some contracts add fees, and precomputed-interest loans do not refund unearned interest the way this arithmetic assumes.
Run your own numbers in the debt strategy calculator →