Managing financial windfalls: should you pay off your debt?

Being in debt has both a financial and psychological impact. Some people worry so much about being in debt that they avoid it all together. They might use every penny they have to pay off debt as soon as it appears.

However, from a financial perspective, there are two big reasons to keep or repay debt. Whether you could save money by repaying debt is determined by:

1. the net cost of your debt – the interest you pay minus your tax deduction.
2. the net return on your wealth – the net income you could earn from your money if you don’t use it to repay the debt.

You should also estimate your future costs and return and compare them:

• If the net return exceeds the net cost, you’re better off holding on to your debt.
• If the net cost exceeds the net return, you’ll save by repaying your debt.

To calculate your net return, you’ll first need to estimate your expected return and deduct any tax you must pay on it. The return on your wealth is taxed in box 3 (income from savings and investments). In 2025, the tax rate is 36%.

Current situation

Tax in box 3 is calculated according to the assumed-return system. This means that the Dutch Tax and Customs Administration taxes you according to a flat rate (assumed return) rather than the actual return. The flat rate is the same for everyone.

If the flat rate is higher than your actual return, you may be able to lower your tax bill by providing evidence that your actual return is lower than the assumed return.

Possible change from 2028

A new box 3 tax regime may be introduced in 2028: the Box 3 Actual Return Act (Wet werkelijk rendement box 3). If so, your assets in box 3 will be taxed according to the actual return. But if the tax rate remains the same, you’ll keep 64% of your return after tax.

To calculate the net cost of your debt, check how much interest you pay on the debt and deduct this from the tax saving you derive from the debt.

This will differ depending on whether your debt is taxed in box 1 or box 3. If it’s taxed in box 3, you’ll also need to consider the flat rate or actual rate.

• If you’re calculating according to the flat rate, there may be a big difference between the tax saving of having debt in box 3 and debt in box 1.
• If you’re calculating according to the actual rate and costs, that difference will be smaller. However, that’s only the case if the interest deduction rates are similar, as they are now: box 1 (around 37%) and box 3 (36%).

Below are some sample calculations to make things clearer.

If you’re a homeowner, you must add a specific percentage of your home’s ‘WOZ value’ (the annual valuation of your home by your local municipality) to your income from work and home ownership (box 1). This is known as the ‘eigenwoningforfait’.

The following percentages apply in 2025:

• Up to a WOZ value of €1,330,000: 0.35%.
• On the amount above that threshold: 2.35%.

Under certain conditions, you may deduct the interest you pay on the mortgage of your main residence in box 1 from your box 1 income.

If you make limited repayments on your mortgage and the interest you’ve paid on the remaining debt is higher than the addition of the ‘eigenwoningforfait’, you’ll usually achieve a tax saving of around 37%. The net cost of the debt is therefore equal to about 63% of the mortgage interest.

Sample calculation

Charlotte owns a home with a ‘WOZ value’ of €400,000 and has a mortgage debt of €300,000 at a 4% interest rate. She has €70,000 in income from work and home ownership (box 1) and an investment portfolio worth €500,000.

Charlotte is considering withdrawing €50,000 from her investment portfolio (box 3) to make extra repayments on her mortgage. The net cost of her debt amounts to 2.52% (63% x 4%).

In this case, making extra repayments on her mortgage works to her advantage only if the net return on her wealth in box 3 (savings and investment) is lower than 2.52%. We use two calculations to determine whether this is the case.

• Calculation with 36% tax on actual return: Charlotte may be better off if her wealth yields less than 3.94% return. Expressed as a sum: 3.94% × (1 – 0.36) = 2.52%.
• Calculation with flat rate: Charlotte is better off keeping her debt (i.e. not making extra repayments) if the minimum return on her wealth is around 4.63%. Expressed as a sum: 4.63% - (5.88% × 0.36) = 2.52%.

Risks of holding on to debt

Holding on to debt is riskier, and it’s important that Charlotte knows this. The return on her investments could be lower than expected. Similarly, her mortgage interest may go up in the future.

It’s also wise to calculate your savings in euros. Is it really worth it? Or does it not outweigh the higher risks? Repaying your debt may give you more control over your finances – something you can’t put a price on.

Repaying your mortgage in full

The calculation becomes slightly more difficult if Charlotte intends to repay her mortgage in full (or almost in full). Under the Hillen law, she’d then pay less tax on her ‘eigenwoningforfait’. To make an accurate comparison, we’ll need to include that tax saving in the calculation.
Under the Hillen Law, Charlotte pays tax on only 23.33% of the ‘eigenwoningforfait’ if she repays her mortgage in full in 2025, with 3.33% added to that each year. As the deduction under the Hillen law will gradually be reduced to zero from 2019 to 2049, Charlotte’s tax saving will decrease each year.

This means the following:

• By repaying her mortgage in full, Charlotte saves around 0.12% extra each year through her ‘eigenwoningforfait’.
• The total net costs she saves amount to around 2.64% (2.52% + 0.12%).
• Conclusion: Charlotte is better off if the expected net return from her investments is lower than 4.13% (tax on actual return) or 4.75% (flat rate).

Calculation according to the actual return

If your debt is in box 3 and your wealth is taxed according to the actual return, the savings from your debt will also be 36% of the interest owed. Conclusion: you save by repaying your debt if your return is lower than the interest on your debt.

Calculating according to the flat rate

In the flat-rate regime, the tax saving from debt in box 3 depends on the flat rate that applies to debts. In 2025, this rate is 2.61%.

Let’s say that the average flat rate for 2026 is 2.61%. And let’s also forget the influence of the tax-free allowance for a second. The calculation is as follows:

• The flat rate saves you 0.94% (36% x 2.61%). 
• The tax on your wealth that you could use to pay your debt is 2.11% (assumed return on ‘investments and other assets’ = 5.88% x 36%).
• This creates ‘tax leakage’ of 2.11% – 0.94% = 1.17%. ‘Tax leakage’ is a part of the extra income that you pay as tax to the government.

In other words: unless the return on your wealth is at least 1.17% higher than the interest you pay on the debt, repaying your debt saves you money.

Sample calculation

Hamza has debts of €100,000 in box 3 (savings and investment) at 4% interest. He has an investment portfolio worth €300,000. In the past years, he achieved approximately 6% return on those investments. He wonders whether he’d be better off repaying or keeping the debt.

To determine this, we use two calculations:

• Based on the actual return: he’d be better off holding on to the debt at 4% interest as long as his investments make an average return of at least 4%. If the return is below that, he’s better off repaying his debt.
• Based on the flat rate: he’s better off keeping the debt only if the return on his investments is at least 5.17% (4% interest + 1.17% ‘tax leakage’).

Extra repayments and fees

In most cases, you can repay a certain percentage of your original loan each year without incurring an early repayment fee.

But if you want to make extra repayments on your mortgage, you may end up paying a fee on that additional amount. This is more likely if the interest on the loan you want to pay off is higher than the going rate for similar loans. To be sure, ask your bank or mortgage provider.

If you’ve incurred an early repayment fee on the mortgage on your main residence in box 1, you can deduct that amount from box 1 on your income tax return.

Endowment mortgage

If you have an endowment mortgage, making extra repayments often won’t leave you better off. There are two main reasons for this:

• The mortgage is linked to a locked-in account or insurer’s endowment policy.
• Your monthly deposits are tax-free assets that you eventually use to repay your mortgage.

A mortgage adviser can calculate whether making extra repayments makes financial sense for you.

Bricks and mortar

Repaying your mortgage or another loan for your main residence means ‘locking’ your money into bricks and mortar. That money then becomes harder to access. In many cases, you can only free it up by selling your home.