So you are about to get your tax return. Should you use it for a down payment? Is it a good idea or not? So here is the big problem. A lot of people, realtors, lenders, everybody in the real estate space, and probably bad advice from your friends. They're going to say absolutely, get a tax return and use it for a down payment without considering anything else.
But I'm going to argue there are good sides and there are bad sides to that. So if you do get a tax return, should you use it on a down payment? Some pros and cons that you need to consider before you do this. Let's go ahead and jump into this.
Should you use your tax return as a down payment? We need to first understand what a tax return is. A tax return means that you overpaid taxes this year. If you were getting money back from the government, you overpaid.
Some people would argue that you gave the government free interest, free money, right? So if you're getting five grand back as a tax return, you gave the government five grand over the year that they could go use interest-free, almost like a loan. And then they're going to end up giving it back to you without interest. So some people view it like that. Some people view it like a forced savings account, but effectively you overpaid taxes. You paid too much in taxes. So during the month or during the year, you could have had a higher monthly income instead of having a tax refund at the end.
So the way that you solve this is through your W4. So you're going to have a tax document from your employer if you are employed. And what you'll do is you'll put on your withholding amount, and your withholding is going to tell your employer, how much taxes to pull out from your pay stub each paycheck. And if you put too much withholding on there, then they're going to pull out a lot of taxes. And then what will end up happening is you most likely will have a tax refund.
If you put less withholding, then you are not going to have a tax refund or you might have to pay taxes. So there is a midline that you have to determine, and there are lots of calculators that you can figure out.
But if you're getting a massive tax refund somewhere in the $5,000 plus range, go back and figure out your withholding. Because instead of getting that money once a year, why not get that money coming in monthly? Don't overpay taxes.
You could be using that money on your own and investing it or using it as savings. Don't just give it to the government for free. So check your withholding on your W4 if you have $5,000 or more in a tax.
Also, do not get a loan for it. Just be patient. What happens a lot of times, I see a lot of people saying I just got approved to get an advance on my tax refund. Don't do that. That's a loan. That's a straight-up loan. No matter what the terms are, it's a loan.
There's no point in getting a loan for money that you're going to get in a few months. You can go without that money. You've gone without it for 12 months, you can go without it for another few months here. There's no point in getting into a loan for tax dollars. And this is your money. You're going to get it back. Don't pay taxes. The money that was taken from you, that you're gonna gets back. It just doesn't make sense. Be patient with that.
Be cautious with people who just blindly say, use your down payment, or use your tax refund for a down payment. This is what I see realtors say all the time and lenders say all the time, I'm getting the tax refund, put it down on a house. I think that's a really poor way for professionals to do business, frankly. Because they're only focusing on one-sided advice that helps them make a sale.
Ultimately, they need to respect you and everything else that's going on in your life, both financially and holistically. And that involves looking at your tax return full circle and not just from one side of real estate. So be cautious of those people who say just buy real estate. Cause they're most like your realtor or a lender.
What are some advantages? Number one is you have an immediate down payment. If you have money saved up, depending on the size of your tax return, you immediately are going to now have an influx of cash that you can use as a down payment or towards closing costs. Maybe it's your soul down payment, or maybe you're adding that to some other savings as a down payment.
But the main benefit of this is that whenever you're closing on a mortgage, you need what's called Seasoned Funds. So funds to close on a mortgage, have to come from a verifiable source, meaning it can't just be loose cash to close on a home. It needs to be funds that have been sitting in your bank account from payroll or from selling something documented or from any other source that's documented like retirement accounts or any other income stream. You can't just use unverified cash or loans to close on a mortgage.
So what happens when you go through a mortgage is they're going to look at large deposits. And the nice thing about a tax return is it's a large deposit, but since it's going to come into your bank account and say, it's from IRS or from the treasury, then it's perfectly acceptable and you're allowed to use those funds without having to verify them because they come straight from the Treasury. Unless they come from one of those loans, which again, don't get a loan for your tax return.
Another advantage to having a tax return to be able to submit towards a down payment is you have forced savings. You could change your withholding so that you don't pay as much, or you don't receive as much in a tax return, but it is nice sometimes to have forced savings.
If you have some spending habits that are a little out of control right now, you should reel those back, but it is nice to have savings in place throughout the year when you get that money back.
Also, an advantage of using your tax return as a down payment is you're putting that money into something that can be set up as an investment. Some people get their tax return and then they go and blow that money. They go and spend it on things that are liabilities that are costs things that they don't need. But if you take your tax return and use it as a down payment, you're now putting it into an appreciating home. So that home is going to go up in value. Your equity is going to increase. You might be able to sell that house for more money than you put into it and have a high cash-on-cash return with your property.
That's a better way to use your tax return than to choose a vacation or purchase electronics that you don't need, which are things that I do too much, not the shoes, but the electronics.
One big disadvantage is you could use that tax return instead of paying it on a down payment, you could use it as savings. So if you don't have an emergency fund right now, this would be a really great way for you to build up an emergency fund.
You can follow a lot of different emergency fund strategies. Dave Ramsey suggests starting out with a thousand dollar emergency fund, and then eventually moving that up to three to six months of expenses in an emergency fund. So if you don't have one right now, an emergency fund is really valuable because it helps you not get into debt further. If you have any emergencies that come up, something goes wrong with a car, you have medical expenses, you need school supplies, something happens where you didn't expect that cash expense and so having an emergency fund, make sure that you don't dive into more debt to cover an emergency.
Then you could also look at using your tax return as a way to pay down debt. You could put it down on a house, which is great, but you also might be able to pay off a credit card or pay down student loans.
Just doing something to take away that high-interest debt would be a really great option. I would focus this mainly on high interest. If you have something that's a lower interest, installment loan, maybe a car loan, or a student loan, maybe focus on the credit cards first, because those are gonna have a higher interest rate. Just get those knocked out if you can.
Also, a big disadvantage is it creates a hasty decision. Because you get this influx of cash, it can be really easy to struggle, to make a decision about what you're going to do with that. And using it as a down payment can be a hasty decision because you're going to see a lot of people around this time of year saying, should you use your tax return as a down payment? It's exactly why I discuss this. It's because I know you're going to hear tons of messages from people saying, yes. Use it to buy a house without considering the whole picture.
So you need to make sure, do you have savings set aside? Are you working on paying down debt? If you are, then let's make a smart decision moving forward on if you're going to use it as a down payment. Because using it as a down payment, it can be a great choice if you have a certain level of financial health, to begin with.
Getting a house is not going to be a blessing for you if you're already in a tough financial situation. If you're in a tough financial situation right now, use your tax return to pay down debt, and build up savings. Help bring you back to some financial health. That way house can be a blessing moving forward.