Don’t we all dream of a big chunk of money landing in our laps? Well, if you’re like millions of taxpayers, you might receive one in the form of a tax refund. Sure, you could go on a shopping spree or take a big vacation. But if you want to spend it in a way that has a bigger long-term benefit, consider putting that money toward your mortgage loan.
Benefits of Paying Down Your Mortgage Loan
Chipping away at your mortgage loan has multiple benefits — three of the biggest ones are:
- It saves on interest. Making extra payments on your mortgage principal can cut thousands of dollars of interest off your total mortgage cost.
- It builds equity faster. As your mortgage balance goes down, your equity (the difference between your home’s value and what you owe on it) goes up. You can tap into your equity if you need it via a cash-out refinance or a home equity line of credit (HELOC).
- It pays off your home faster. Who hasn’t fantasized about not having a house payment? Paying extra on your mortgage can chop months, or even years, off your loan’s length.
Should You Pay Your Tax Refund Toward Your Mortgage?
Although it’s often a wise financial decision to put your tax refund toward your mortgage, the answer to this question is not always yes. It depends on your personal financial situation and future plans. Before you plunk down this year’s tax return on your mortgage loan (or decide to go ahead and spend it), ask yourself these questions:
- Do I have credit card (or other high interest) debt?
Carrying a balance on your credit cards is a slippery slope. It’s not unheard of for credit card debt to incur staggering interest rates of well over 20%! If you have credit card debt with high interest rates, it may be smarter for you to pay those off before you focus on paying down your mortgage loan.
- Do I have an emergency fund?
A cash cushion gives you the peace of mind that you can pay for life’s emergencies like an illness, vehicle repair, or home repair. If you don’t have an emergency fund, you may end up covering these issues with a credit card, and that can be a slippery slope. If your savings account is low or nonexistent, your tax return may be better used as a rainy day fund than as an extra mortgage payment.
- Am I saving enough for retirement?
Retirement age will be here before you know it and you definitely want to be ready. Are you maxing out your job’s retirement options and adding to an IRA (if applicable) every year? If you’re not saving enough to retire comfortably, consider depositing your tax return into your retirement plan.
- Will I be experiencing a big life event in the next two years?
Think about the next few years of your life. Are you going to have a child? Get married or divorced? Move? Is your spouse going to quit their job? Do you want to start a new business? Examining your upcoming plans gives you an idea of whether you’ll need access to your tax return, or if the time’s right to pay down your mortgage with it.
- Will I be sending my kids to college?
College is flat-out expensive. If you have college-bound children and you’re going to cover the costs, you may be better off stashing your tax return in a college fund than putting it toward your mortgage. However, if you don’t have kids or if they’re grown and already educated, your tax return may be freed up to pay toward your mortgage.
- Does my loan have prepayment penalties?
Some mortgage loans have penalties attached to paying it off early. If your loan has a prepayment penalty, sending in a large extra payment may not benefit you as much as using the cash for something else.
Deciding on whether you should pay your tax refund on your mortgage principal or if it’s better off somewhere else is a personal decision. Answering the above questions can give you an idea of the choice you should make.