The basic calculation
Every euro you repay early lowers the remaining debt. From that moment on, no interest accrues on that euro until the end of the term. An extra repayment therefore works like an investment that earns exactly the loan rate: no market risk, no tax, from day one.
Effect of an extra repayment after n years
An example: €10,000 repaid early at a 3.5 % rate. After ten years, the remaining debt is €14,183 lower than without the extra repayment; €4,183 of that is interest saved. If the payment stays the same, the loan is paid off correspondingly earlier.
With an ETF, the return is open. Broadly diversified equity ETFs can earn considerably more than the loan rate, but also less for years at a time, and the gain is taxed.
When the ETF comes out ahead
For the ETF to break even on average, it has to reach the same end value after tax as the extra repayment. In Germany, gains on equity ETFs are taxed at 25 % plus solidarity surcharge, on 70 % of the gain (partial exemption). That is effectively about 18.5 % of the gain, without church tax.
| Loan rate | ETF return needed before tax | ETF ahead at 6 % expected |
|---|---|---|
| 1.5 % | 1.8 % | 73 % |
| 2.5 % | 3.0 % | 65 % |
| 3.5 % | 4.2 % | 56 % |
| 4.5 % | 5.4 % | 47 % |
| 5.5 % | 6.6 % | 36 % |
Ten years, owner-occupied home; last column: share of 2,000 simulated paths with 6 % expected return and 15 % volatility in which the ETF ends ahead. As a rule of thumb, the ETF needs about a fifth more return before tax than the loan rate. If your saver’s allowance of €1,000 a year (€2,000 for couples filing jointly) is not yet used up, the tax falls and with it the return needed.
Certain versus likely
Breaking even on average does not mean breaking even in every case. The example with €10,000, a 3.5 % loan rate, ten years and an ETF with 6 % expected return and 15 % volatility:
| After ten years | Value after tax |
|---|---|
| Extra repayment, certain | €14,183 |
| ETF, median | €15,038 |
| ETF, average | €16,456 |
| ETF, worst tenth | below €8,674 |
| ETF, best tenth | above €26,158 |
The ETF ends ahead in 56 % of paths and earns a good €2,200 more on average. In the other 44 %, less is left than with the extra repayment; in the worst tenth, even less than the amount invested. The median is below the average for a reason: a few very good paths pull the average up. For a single decision, the median is the more honest number.
With your numbers
Prefilled with the example. The interest rate is in your loan agreement; a good period to compare is the time left in the fixed-rate period.
The property is
After 10 years
Extra repayment
€14,183
lower debt, earns 3.50 % for sure
ETF, median after tax
€15,038
80 % of paths between €8,674 and €26,158
In 56 % of 2,000 market paths, the ETF ends ahead.
Break-even: the ETF has to return 4.2 % a year before tax to match the extra repayment on average.
Value of the amount over time
ETF sold at the end; tax on the gain: 25 % plus solidarity surcharge on 70 % of the gain (partial exemption), without allowance, church tax and advance lump sum. Let property: the saved interest would have been deductible, so it counts after tax. Not a recommendation.
Let property
For a let flat, loan interest is a deductible expense and lowers your tax. Repay early and that advantage is lost: the extra repayment only earns the rate after tax. At a 3.5 % rate and a 42 % marginal tax rate that is about 2.0 %. In the example, the ETF then ends ahead in 68 % of paths, and 2.5 % a year before tax is enough for it to break even on average.
If you have financed both your own home and a let flat, an extra repayment on the home loan earns more on paper, because no tax advantage is lost there. How interest, principal and tax interact for a let flat is shown in Cash flow after debt service.
What the loan contract allows
- Agreed extra repayments: during the fixed-rate period only if the contract provides for them. 5 % of the loan amount a year is common, some contracts allow 10 % or more, often for a slightly higher rate. Unused amounts usually lapse at the end of the year.
- More than agreed: for a fixed-rate property loan only with a legitimate interest, such as selling the property, and against a prepayment penalty.
- After ten years: ten years after the loan was fully paid out, you can terminate any fixed-rate loan with six months’ notice, without a prepayment penalty.
- When the fixed rate ends: before the follow-up financing, you can repay as much as you like.
Liquidity and refinancing
Repaid money is tied up. If you need it later, you only get it back through a new loan, on the terms that apply then. An ETF can be sold at any time, if perhaps at a loss. This flexibility appears in no return calculation, but it is often the real reason behind the decision.
On the other hand, a lower remaining debt reduces interest rate risk. If the fixed rate ends at a time of high rates, less of the loan has to be refinanced expensively, and if the loan-to-value is then below thresholds such as 60 or 80 %, banks often offer better terms. What happens when the fixed rate ends is worked through in When the fixed rate ends.
Questions that frame the decision
There is no general answer. These questions help you find your own:
- Is there an emergency reserve that stays available whichever way you go?
- How high is the loan rate, and does it count before or after tax?
- How long is the period? The shorter it is, the more the ETF’s volatility weighs.
- How much is certainty worth to you compared with a higher but uncertain return?
- Is the follow-up financing coming up soon, and how much interest rate risk depends on the remaining debt?
The decision does not have to be all or nothing: splitting the amount buys a share of certainty and keeps a share of the upside.
Sources
- 01§ 489 BGB (German Civil Code): borrower’s right to terminate
- 02§ 500 BGB: early repayment of consumer loans
- 03§ 502 BGB: prepayment penalty
- 04§ 32d EStG (Income Tax Act): flat tax on investment income
- 05§ 20 InvStG (Investment Tax Act): partial exemption for equity funds
Rules and figures as of