Use Your Tax Refund to Make Your Mortgage Work For You

April 8, 2024 — 2 min read

It’s definitely tax season; can you hear the collective groaning of the masses? Don’t worry—your refund is likely coming, too. With the 2023 average refund totaling $2,753, you may already be dreaming about your next fun vacation. But before you hit “add to cart,” it’s worth researching how to use your tax refund to pay down your mortgage instead.

According to CNBC, 28% of surveyed U.S. taxpayers plan to save their tax refund, while 19% plan to use it to pay off debt. What if you could do both? When you pay down your mortgage using your tax refund, you are doing both: saving money and lowering your loan-to-value ratio.

Should I Use My Tax Refund To Pay Down My Mortgage?

That vacation may be appealing, but if you’ll be paying interest for 30 years, it may be a good idea to pay down your mortgage. Why? You’ll pay less interest in the long run since the principal will be smaller. You’ll also be building equity more quickly, meaning you’ll own more of your house sooner than if you’d spent your tax refund elsewhere. Your tax refund may also be able to help you pay fees associated with refinancing if you’re seeking a lower interest rate or shorter loan term and eliminating private mortgage insurance (PMI) that may have been required if your down payment wasn’t 20% or more of the cost of your home.

If you’ve decided to pay down your mortgage with your tax refund, there are a few ways to go about it:

Use Your Tax Refund To Pay Down the Principal

This is likely the simplest, most straightforward way to apply some savings with your tax refund.
Make a lump sum, one-time payment toward your principal with your tax refund, and you effectively decrease the total owed on your mortgage, shorten your loan period, and build up equity, bringing you closer to fully owning your home. Using your tax refund to pay down your principal can lower the amount you pay on interest over the life of your loan.

A NOTE ON PAYING DOWN THE PRINCIPAL

When you make your one-time, lump sum payment with your tax refund, ensure it goes to your principal amount, and isn’t considered an “early payment”. Also, check that your lender won’t enact prepayment penalties. This may occur if a specific percentage of your principal is paid off before a specific date. Review the terms of your loan with your lender and ask any questions before you make that large payment online.

Additionally, some lenders may allow loan “recasting”—taking the new, lower remaining balance and reamortizing your loan with the same term and interest rate, but with a lower principal.

If you’re hoping for more options to lower your monthly payments, you may want to explore refinancing.

RELATED: Why Pay Your Mortgage Early

Use Your Tax Refund To Pay For Refinancing Fees

A refinance is effectively a brand-new loan that replaces your old mortgage. If you’re hoping for smaller monthly payments and lower interest rates for the remainder of your mortgage, refinancing may be the right option, using your tax refund to cover any fees associated with refinancing.

This lower interest rate after refinancing could be due to a few factors:

Mortgage rates may be lower now than when you took out your original loan.

OR
You may be offered a lower interest rate if you’ve improved your credit score or your debt-to-income ratio is lower after paying off credit cards or student loans.

Try to aim for a rate drop in interest of about 2% or more to make the process and fees worth it. (e.g. Refinance for a loan with no higher than a 6% interest rate from a loan at 8%.)

You might also be interested in refinancing to get a stable monthly payment and switch from an adjustable-rate mortgage (ARM) to a 30-year fixed-rate mortgage.

A NOTE ON REFINANCING FEES

You’ll have to spend a little money to save money with refinancing. Yes, you may get a shorter loan term or a lower interest rate, but you will also need to pay for closing costs and possibly appraisal fees—which is where your tax refund comes in.

According to The Mortgage Reports, closing costs average 2-6% of the total loan amount. The cost of your refinance will also vary based on where you live, your credit score, and your previous and current lender’s requirements.

RELATED: Understanding Closing Costs

Refinancing may not be for you if:

You’ve just taken out your original loan—some lenders will not refinance if your loan began 120-180 days ago
The interest rate you’re offered is not more than 2% lower than your current rate
You’re planning to move and sell your home soon
Your new loan term is a lot longer—you’ll pay far more in interest

It’s always a good idea to do a cost-benefit analysis to determine whether refinancing really will save you money in the long run. If you’re unsure whether refinancing will work for you, reach out to our mortgage advisors. Our staff will guide you while considering your unique financial goals.

REMOVING PMI THROUGH REFINANCING

Private mortgage insurance (PMI) is added to mortgage costs when the borrower makes a down payment of less than 20% of the total house cost. If you can refinance, you may secure a lower interest rate and make a larger down payment to eliminate the need for PMI—as soon as the amount paid is 78% of the total principal. A cost savings of .005-.006% of your principal on your monthly bill may be worth it. Some loans allow for early cancellation of PMI, but you’ll have to check in with your specific lender.

RELATED: Harp Refinance is Gone, What Should We Do Now?

Use Your Tax Refund For A Down Payment on New Home

If you’re not already a homeowner but you’ve been considering purchasing a new home, your tax refund can help you buy a new home. Putting your tax refund into your down payment can help you secure a lowered interest rate and make the pre-approval process smoother, since whatever you’re putting down is considered immediate equity in the home. You may also be able to avoid private mortgage insurance if you boost your down payment to 20% or more of the total cost of the home.

Improving Your Tax Refund—Tax Deductions and Credits

Was your tax refund insufficient to boost your home finances this year? There are a few ways to make the most of your tax deductions and possibly increase your tax refund for next year.

TAX CREDITS

Mortgage Credit Certificates - This dollar-for-dollar state tax credit allows homebuyers to claim part of their annual mortgage interest as a federal tax credit. (This helps make home payments for recipients more affordable.)

TAX DEDUCTIONS

You may be able to deduct your mortgage interest payments, generally up to the first $750,000 on your loan (or $375,000 if you’re married, filing separately). If you purchased mortgage points, you can deduct the cost of discount points you purchased through an upfront fee as interest when you file, if you meet certain qualifications.