Before you go spending your tax refund on having some fun, first stop and consider what you can do with it that might take care of you and your family for many many years. One of the best ways to do this is by using your tax refund as a down payment on your first home. Think of it as investing your tax refund, rather than spending it.
How Your Tax Refund Can Help You Buy a House
For many would-be homeowners, accumulating money for a down payment is the single biggest obstacle to homeownership. The combination of low pay increases and the high cost of living make it very difficult to save money at all, let alone the amount needed for a major purchase, like a home.
Buyers often resort to a variety of sources in order to come up with a down payment. That can include a combination of personal savings, gifts from family members, and even the sale of assets. But an often overlooked source of funds for a down payment is your income tax refund. That’s unfortunate because a tax refund can amount to several thousand dollars.
According to the IRS, the average income tax refund was $3,218 for the 2015 tax year.
If saving money for a down payment is difficult to do, never overlook your tax refund.
Why Using Your Tax Refund to Buy a House is a Great Strategy
An income tax refund is actually a forced savings plan. Think about it – the money actually comes out of your paycheck and is then forwarded to the IRS in payment of your anticipated tax liability. But since most people over-withhold, they get some of the money back. So in a real way, you spend the entire year “saving money” through your tax withholding, just as you would with any other payroll savings plan.
If you don’t have much luck with saving money otherwise, then your tax refund represents an important part of your overall financial strategy. Like a tax-sheltered retirement plan, your income tax refund is a major part of your savings.
For that reason, you should want to match that savings plan with an important goal. In fact, your objective should be to invest your tax refund into your future. That’s exactly what you will do if you use your tax refund for the down payment on a house.
Since the house will be a long-term investment, you will be using your tax refund as part of that overall plan. That ensures that your most recent tax refund will continue to provide future rewards to you and your family, in the form of the shelter that a house provides, as well as the equity build-up that comes from owning a home for many years.
Your Tax Refund Could be Some or All of Your Down Payment
Now that we’ve established the importance of using your tax refund for a long-term financial benefit, such as the purchase of a home, let’s take a look at the mechanics of how you can use it.
If you get a larger than average income tax refund, you can actually provide all of the cash necessary for your down payment. Since FHA mortgages typically require 3.5% of the purchase price as a down payment, and conventional loans often require no more than 3%, your tax refund can represent your entire down payment.
For example, let’s say that you are purchasing a property for $200,000. If you are taking a conventional mortgage, and need to provide a 3% down payment, that will mean $6,000. Even if you get an average tax refund – about $3,000 – that will represent half of the required down payment. That will reduce the amount that you need to save from other sources, or request as a gift from family members.
But if you are in the habit of maximizing your income tax refund – and many people are – you might get the full amount of the down payment from your refund. That would eliminate the need to save money through other methods that may be less convenient and not as effective.
Using Your Tax Refund for Purposes Related to the Purchase of a Home
Even if you don’t use your tax refund specifically for the down payment on the house, it can still help you to realize your goal of becoming a homeowner.
For example, the refund could be used to pay for the closing costs on the property. It can also be used to pay off debts, and that might improve your ability to qualify for a mortgage, particularly a larger one.
Finally, it’s never a bad idea to have extra money set aside after you close on the new home. When you purchase a home, there will be additional needs. This can include repairs on the property, improvements, such as new carpeting or window treatments, or even the purchase of furniture. Having the extra cash available after closing will mean that you will not have to turn to credit cards to pay for those extra expenses.
What Will Happen to Your Tax Refund if You Don’t Use it as a Down Payment
There’s actually a major downside if you don’t use your tax refund for future investment, like the purchase of a home. If instead, you spend the money on a short-term desire, such as a vacation or a spending spree, the refund money will be gone, and all you will have left will be your memories of what you spent the money on.
But if you use the refund to purchase a home, it can provide you with benefits – quite literally – for the rest of your life. That’s the kind of investment that you need to make with the money that you get from a long-term savings plan, like a tax refund.
So when you get your tax refund this year, use it for something that will help you and your family for years to come. Invest it in the down payment on your first home.