Should I Use High-Yield Savings or Pay Off Debt?

The comparison

Both paths spend exactly the same amount of cash every month, and both are measured on the same date — the day the debt would have been cleared had you never overpaid. Comparing a shorter plan against a longer one is the most common way these calculators go wrong, because the plan that finishes sooner looks better simply for having stopped earlier.

Path A pays the minimum plus your spare cash until the debt is gone, then puts the entire former payment into savings for every month remaining to the horizon. Path B pays only the minimum for the full term and banks the spare cash from the first month.

That last step in Path A is the one most tools leave out. Without it, the money freed up by clearing the debt early simply vanishes from the model, which quietly overstates the case for paying down early. It is also what makes the two paths comparable at all: the monthly outflow is identical, so nothing is being smuggled into either side.

Why the two quoted rates are not comparable as quoted

A savings account and a debt are the same quantity with opposite signs, which makes this one of the few financial questions with a genuinely clean answer. Retiring a dollar of debt earns you the debt’s rate, guaranteed, and the government does not tax it — there is no income event when you avoid interest. Earning a dollar of savings interest is taxable in the year you earn it.

So a savings account quoting 4.25% in a 24% bracket is really paying 3.23% to you. Comparing that 4.25% against a 5.90% loan rate understates the gap; the honest comparison is 3.23% against 5.90%.

Turned around, the useful figure is the rate a savings account would have to quote to break even. Setting the after-tax yield equal to the debt rate — y × (1 − t) = APR — gives y = APR ÷ (1 − t). At 5.90% and a 24% bracket that is 7.76%, which is well above what any insured deposit account pays.

The arithmetic

The debt uses the standard amortization formula, M = P × [r(1 + r)ⁿ] ÷ [(1 + r)ⁿ − 1], where P is the current balance, n the months remaining and r the annual rate divided by twelve. Interest is rounded to the cent each month, exactly as a servicer would, and the final payment absorbs the accumulated rounding remainder so the balance lands on precisely zero.

Extra payments are applied straight to principal in the month they are made, which shortens the term rather than reducing the scheduled payment. That is how nearly every US consumer loan behaves unless you specifically ask the servicer to re-amortize.

Savings are credited at the end of each month at one twelfth of the after-tax yield, and the tax drag is applied to the return itself rather than deducted as a separate line. Compounding monthly on a quoted APY slightly understates the balance, since an APY already includes the effect of compounding; the difference is a few dollars over a four-year horizon and it errs against saving rather than for it.

The breakeven APY is found by bisection between 0% and 20%, halving the interval until it is narrower than one basis point. It is cross-checked in the test suite against the closed form above, which is a stronger guarantee than a model that merely agrees with itself.

What this comparison deliberately ignores

Liquidity, which is the real reason to hold savings despite the arithmetic. Money in a deposit account can be spent tomorrow. A dollar paid onto a loan is gone until you borrow it back, and if the reason you need it is that you lost your income, that is exactly when borrowing is hardest. This calculator has nothing to say about that trade, and the arithmetic here should not be read as advice to run without a cash buffer.

Rate variability. A savings APY is variable and can be cut the week after you open the account; a fixed-rate loan cannot. Holding both constant for the whole term flatters the savings side.

Tax treatment that is kinder than ordinary income. Treasury bills are exempt from state and local tax, and municipal money-market interest can be exempt from federal tax. Neither is modelled — if you hold either, the required breakeven yield is lower than what is shown here.