Thinking of Using your Tax Return for a Down Payment? Read This First
It’s not uncommon to start mentally spending your tax refund the moment you find out that you’re getting one (mine is already earmarked for new rain gutters). That’s doubly true if you’ve been dreaming of buying a new home.
That sudden influx of cash may seem like just what you need to turn your dreams of homeownership into a reality, but is using your refund as a down payment on a new home really the best idea?
Two finance pros share the questions you should be asking yourself before you decide.
Are you already in good financial shape?
A lot of people use their tax refund as a “forced savings account,” or as a way to save up money without actually having to put some aside each month. If that sounds like you, then tax season is likely the only time you’ll find yourself in a financial position to create (or grow) an emergency fund, or pay down large debts.
The two things that Kimberly Palmer, a personal finance expert at NerdWallet, says you should definitely do before you start thinking about buying a new home? “A top priority should be paying off expensive debt, which includes credit card debt, since it typically carries an interest rate of 17 percent or higher,” she says. Similarly, she suggests making sure you have enough money saved up ahead of time to cover between three to six months worth of estimated expenses. Owning a home is pricey—and full of surprise costs.
Have you considered all the other costs that will come along with buying a new home?
The down payment is just one of the many costs you’ll encounter once you become a homeowner. At some point, you’ll inevitably need to shell out money for things like unexpected repairs and general upkeep (like replacing your rain gutters). “If your house suddenly develops a leak, or a tree falls on the roof, you want to be sure you can cover those costs without turning to credit card debt,” Palmer says.
Are you confusing a sudden influx of cash with being financially stable?
It may be tempting to conflate dollar signs with stability, but Brian Walsh, a certified financial planner and SoFi‘s manager of financial planning, says that’s a mistake that could potentially cost you. “I have seen individuals see a large balance in their checking account after a tax refund and spend it in an impulsive manner,” he says. “Many people do not associate buying a home with an impulse purchase, but it can happen.” Walsh says prospective buyers should ask themselves whether they can really afford their new expenses (like taxes, insurance, and a hefty new mortgage payment) once that tax refund has been spent. And if they can, they should confirm they’ll still be able to do things like add to their emergency fund or save for retirement.
If you can’t do that, you may want to put this year’s return into a savings account and set your sights on next year’s return for a down payment.