When a bonus or lump sum lands, everyone wonders: pay down the loan, or save and invest it? The answer is in the numbers, not preference. The principle is simple — if you can reliably earn more than your loan rate, invest; otherwise, pay it down. Add tax and psychology, and here's how to decide.
The basic rule: rate vs. return
Paying down a loan is like locking in that rate, tax-free. A 5% loan rate means repaying earns you a guaranteed, tax-free 5%. So the comparison is:
| Comparison | Verdict |
|---|---|
| Loan rate > after-tax return | Pay down the loan |
| Loan rate < after-tax return (if certain) | Investing worth considering |
| About equal | Whichever eases your mind (usually paying down) |
"After-tax" is the key. Interest and dividends in Korea are taxed 15.4%. A 5% deposit nets about 4.23%. But the interest you save by repaying is untaxed — which is why paying down usually wins.
Compare on an after-tax basis
| Option | Headline | After tax (15.4%) |
|---|---|---|
| Time deposit | 4.0%/yr | ~3.38% |
| Installment savings (at maturity) | 5.0%/yr | ~4.23% |
| Repaying a 5% loan | — | 5.0% (tax-free) |
So at a 5% loan rate, parking cash in a 3–4% after-tax deposit loses money. Check after-tax deposit returns with the savings maturity calculator, and compounding with the compound interest calculator.
When investing may still win
- Very low loan rate — policy or low fixed-rate loans (say ~2%) leave room to beat them after tax
- No emergency fund — repaying to zero cash is risky; keep a few months of living costs first
- Large prepayment penalty — if repaying is costly, run the penalty and compare to interest saved
- Tax-advantaged accounts — pension/IRP accounts with big tax credits are worth funding separately
Example: you get ₩20 million
Spare cash of ₩20M, loan balance ₩50M (5% rate, year 4 so penalty is 0). ① Repaying ₩20M locks in ~₩1M/year (tax-free 5%). ② The same in a 4% after-tax deposit earns ₩800,000/year. ③ With no penalty, paying down clearly wins. ④ But with no emergency fund, keep part (3–6 months of expenses) and repay the rest. If a cheaper loan exists, also weigh refinancing.
Recommendation by situation
| Situation | Recommended |
|---|---|
| High-rate loan (5%+) + spare cash | Pay down first (tax-free, certain return) |
| Low fixed-rate loan (~2%) | Investing for a higher after-tax return worth considering |
| No emergency fund | Secure 3–6 months first, then repay |
| Room in pension/IRP | Fund up to the tax-credit limit, then repay |
| Multiple loans | Highest rate first |
One line: higher rate → repay; low rate or tax perks → invest, and always keep an emergency fund first.
Decision checklist
- ☐ Know your loan rate (could rise if variable)
- ☐ Compute the after-tax return of the alternative (apply 15.4%)
- ☐ Have an emergency fund (3–6 months)?
- ☐ Any prepayment penalty?
- ☐ Psychology: the relief of less debt is a real, if intangible, gain
FAQ
Q. What if stocks beat my loan rate?
The expected return is higher but not guaranteed. Repaying is a certain return; stocks are an expected one. Invest only with money that can bear loss, and keep the loan managed safely.
Q. Emergency fund or loan repayment first?
Usually a minimum emergency fund first, then high-rate debt. Repaying everything with no cushion can force you into pricier borrowing later.
Q. Pension/IRP tax credit vs. repaying?
Pension/IRP contributions earn a sizable tax credit (13.2–16.5%), so funding up to that limit is often worthwhile; use extra beyond it for high-rate debt.
Q. Multiple loans — which first?
Mathematically, the highest-rate one first. Clearing small ones first feels rewarding, but highest-rate-first minimizes total interest.
Paying down a loan is a tax-free, guaranteed return. If your after-tax return can't reliably beat the loan rate, repay — but keep an emergency fund.
This is general information, not investment or financial advice. The answer depends on your rate, taxes, and situation — use it as a guide only.
