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This is the third post for our Prepayment Strategy Series (check out all the posts in this series).

Tax Refund

Now that 2012 is upon us many of us start working on gathering everything we need to file our taxes.  We are receiving our W2s, 1099s, Mortgage Interest Statements, etc so we can calculate our anticipated tax refund.  After paying so much in taxes throughout the year this is the one time some of us actually get money back from the IRS.  I don’t know about you but it is always a nice surprise when I get my tax refund.  What should you do with the money though?  If you have followed my recommendations about setting up your finances for success, then maybe you should apply that tax refund to your mortgage.

Average Refund and Inflation

Of course, we have no idea what the average tax refund amount for 2011 will be at this time but if it is anything like past years it should be right around $3,000.  Another factor we need to consider in the average refund amount is inflation and the increase of the refund over time due to the lower value of the dollar over time.  The average inflation rate since 1913 through Dec 2011 was 3.43%.  That means something that costs $100.00 today will be 3.43% more expensive next year, or $103.43.  If we look at the average refund amount of $3,000 from 2010 we can expect the average refund for 2011 to be $3,102.90 (an increase of 3.43%).  This will continue every year into the future based on the historical inflation average.  I know we are getting a bit detailed in the numbers here but I am explaining this so we have a basis for how much of an impact using your entire tax refund towards a prepayment on your mortgage will have over time.  Let’s take a look at the numbers…

Tax Refund Applied to Mortgage

We are going to stick with the same loan amount, purchase date, etc from our first example.

  • Loan Amount = $186,500
  • Rate = 5%
  • Term = 30 Years, Fixed

Overview of Mortgage with no Prepayment

  • Minimum Payment: $1,001.17
  • Payoff Date: Feb 1, 2042
  • Interest Paid Over 30 Years: $173,922.04

$3000 Applied Every 12 Months Adjusted with Inflation at 3.43%

  • Total Payment: $1,001.17
  • Additional Payment Per Year:  $3,000 adjusted by 3.43% annually
  • Payoff Date: Aug 1, 2032
  • Early Payoff:  113 Months
  • Interest Paid Over Full Term: $150,835.41
  • Interest Saved Over Full Term:  $23,086.63

By applying your entire tax refund, based on the average amount of $3,000 each year (increased with inflation), you would save over $23,000 and payoff your mortgage over 9 years early!!

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