Should you use your tax refund to pay down your mortgage?

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If you’re expecting to receive a tax refund this year, you may be wondering about the best way to use it. If you’re a homeowner, you might have considered putting it toward your mortgage. After all, the faster you can pay down your mortgage balance, the faster you’re able to build equity. But is this really the best way to use your tax refund? The answer may be different for different people, and may depend on several different factors. We’ll explore some of those factors in this post.

Before you decide to put your tax refund toward your mortgage, consider the following:

Do you have high interest debt that needs to be paid off?

If you have balances on your credit cards or any other type of debt with a high interest rate, it would make more sense for you to concentrate on eliminating that debt first. Most financial experts will agree that mortgage debt is one of the “good debts” to have, as it helps you build an investment and interest rates are comparatively much lower than credit cards. Therefore, hanging on to your mortgage debt isn’t the end of the world – in fact, it can sometimes be beneficial. With credit card and other high-interest debt however, it can be a financial burden with really no benefit. With mortgage debt, at least you are allowed to deduct the interest you’ve paid each year – not so with credit cards.

Do you have an emergency savings fund?

If you have little to no money set aside for an emergency, now’s the time to set up an emergency savings fund instead of paying down your mortgage. Use your tax refund to open a savings account with your bank, or simply deposit the money to an existing savings account.

How about retirement?

If you have no credit card debt and you have at least three months’ worth of living expenses saved up, then consider yourself way ahead of the game! But what about your financial future? Have you set up a retirement fund? If not, now may be the perfect time to do so.

Paying Down Your Mortgage With Your Tax Refund

If you’re sure you have all your other financial ducks in a row, and you feel confident that putting your refund toward your housing costs is the best way to go, great! But keep in mind there’s more than one way to go about doing this, and some methods may be better for your situation than others.

Option 1: Making a one-time prepayment

You can choose to make one large extra payment toward your mortgage in order to reduce your principal balance. Keep in mind that doing this will most likely not lower your monthly payment, but rather will reduce the length of the loan. If the home is not your “forever home,” and you plan on selling it someday, this is probably not the best choice. It may make more sense to go with one of the other options below.

Option 2: Refinancing

If you’re more concerned with lowering your monthly payment, you could use the money from your tax refund to pay for a refinance loan. Refinancing lets you take out a new loan for the amount you owe on your current mortgage, and usually at a lower interest rate. Refinancing may require paying closing costs and some fees, so your tax refund could help pay for those expenses, and you’ll be able to save money month-to-month with a lower interest rate.

Option 3: Withdraw portion of refund each month to help cover mortgage bill

If for some reason you are unable to refinance (perhaps you’re underwater in your mortgage and don’t qualify for HARP), another way you can use your tax refund to save on your mortgage payment is to put it in savings, and simply withdraw a bit from it each month to go toward your mortgage bill. Of course, this is not a long term savings solution, but if you’re going through a rough patch financially, it might help you get back on track. Naturally, how long and how far the savings will go will depend on two things: how much your refund is, and how much you put toward your mortgage each month. If you get a refund of $5,000 and use it to put $100 toward your mortgage every month until it runs out, it will last you 50 months or a little more than four years. If your refund is only $2,500, you’d have to divide the portion being put toward your mortgage in half to make it last as long.

Avoiding Foreclosure

If you’re a homeowner who is worried about being able to afford your mortgage payments, seek help as soon as possible. Don’t rely on your tax refund to keep you afloat, as this is only a short term fix. There are government and non profit organizations that may be able to help you find more viable solutions to avoiding foreclosure. Here are a few we found on the web:

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