Should You Use Your Tax Refund to Pay Down Your Mortgage Sooner?

Many people who file a tax return end up getting a refund from the IRS. And as of March 3, the average IRS refund issued this season was $3,182.

If you're getting a refund that's comparable in size, there are a lot of savvy things you can do with that money. And you may be thinking of using that money to make an extra mortgage payment to get your home paid off ahead of schedule. That may not, however, be the best use of your refund.

When you have a low mortgage rate

It's one thing to look at putting your tax refund into your mortgage if you're paying somewhere in the ballpark of 7% on that loan. But many homeowners refinanced their loans when mortgage lenders began offering record-low rates in 2020 and 2021. People in that boat may be paying 3% or less on their home loans.

What's more, those who first signed their mortgages during that time frame, and even shortly thereafter, may be sitting on mortgage rates that are extremely competitive. And it doesn't make sense to pay down a loan with a very low interest rate.

Right now, as an example, many high-yield savings accounts are paying around 4%. So if you have a 30-year mortgage at 2.9%, why put your tax refund into your home loan when you could instead put it into the bank and earn more interest than what your mortgage charges?

When you have more pressing financial needs

Maybe you signed your mortgage more recently and got stuck paying a pretty high interest rate as a result. In that case, it could make sense to use your tax refund to pay down your mortgage sooner. But before you do, ask yourself whether you have a more pressing need for that money. 

Here are some reasons to not use your refund for early mortgage payoff purchases:

• You don't have three months' worth of living expenses socked away in an emergency fund
• You owe money on credit cards
• You have a different type of loan you're carrying with a higher interest rate than your mortgage
• You're anticipating a large expense in the near future (such as if your car is old and having trouble, and you expect to need a new one within a year)

Also, if you haven't begun to fund a retirement account, you may want to consider putting your tax refund into an IRA or 401(k). It's important to save for retirement at as young an age as possible so your money has time to grow. If you get a $3,000 tax refund this year and invest it in one of these accounts at a yearly 10% return, which is in line with the stock market's annual average over the long term, in 30 years, it'll be worth a little over $52,000. 

Of course, if you don't have a more pressing financial need to address and have a high interest rate on your mortgage, then by all means, take your tax refund and make an extra payment on that home loan. But first make sure it doesn't make sense to go a different route.