If you just filed your taxes and discovered that you’re getting a large tax refund,
that’s great news! It’s a chance to do something smart with a fairly large chunk of money. But what should your
priorities be? Should you use that tax refund to pay down or pay off credit card debt, or is it wiser to park that
money in your savings as an emergency fund?
A look at your debts and priorities will help you decide how to use your tax refund
as wisely as possible. Paying down your credit card balances is great for your credit to debt ratio and your credit
score, but there are other factors to consider, too.
Using your tax refund for credit card debt
It’s a smart idea to use at least a large chunk of your tax refund for paying high
interest credit card debt. If your credit cards carry an interest rate of 18 percent and your car loan has an
interest rate of 5 percent, you can see why it would make sense to pay down the card and instead of paying off the
car. And when you free up more of your credit, you improve your credit to debt ratio – and thus improve your credit
Using your tax refund for an emergency fund or savings
If you’re the kind of person whose credit cards are all at a zero balance, you
should probably add most or all of the tax refund to your savings account or emergency fund. But if you do have
credit card balances, even if you can pay off your entire credit card debt with your tax refund, if it’s going to
leave you with no cash to put in savings (and you don’t have any existing savings to speak of), you should probably
keep at least $1000 at a minimum for a basic emergency fund.
Sure, with your credit cards paid off or paid down, you have more of a balance to
work with – but you know that if you have to use a credit card for emergency expenses, unless you’re very
disciplined, it’s all too easy to let that balance grow larger and larger without paying it down. And that can
negatively affect your credit score.
Making the most of your tax refund
If you have zero balances on your credit cards and a well-padded emergency fund in
place, you can still use the refund wisely. Some ideas:
- Contribute to your IRA so you’ll have more of a deduction next year
- Set up and contribute to a 529 savings account to help fund your child’s future. These accounts help you save
for college tuition and expenses, and you can use the money for college bills tax-free.
- Fix up your car to make it last longer (and head off future repairs or emergencies)
- Make home repairs or improvements that help you save on utility bills
There are many smart ways to use tax refund money and other financial windfalls,
but only you know what is best for you and your specific credit situation. It’s your money – make it work as hard
as possible for you!