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Using Your Tax Refund to Pay Down Debt

Thomas-Bright-photoBy Thomas Bright

If you waited until April 15 to file your taxes then your next big milestone might be just around the corner. What milestone am I referring to? Your tax refund coming from the IRS! Exciting stuff isn’t it? Before you get ahead of yourself and start thinking about how you’ll spend it, though, you need to reconsider what a refund really is, and you might want to consider using it as a debt repayment tool.

The Sad Truth About Tax Refunds

The first thing you need to do is establish what a tax refund really is. No sugar coating here. A tax refund represents money you’ve been unnecessarily giving to the government. Sure there are exceptions, but most of us are just overpaying. If we kept the money ourselves, we could invest it either in short-to medium-term investments or toward our retirement. Or, if we weren’t quite ready for that commitment, we could keep the money on hand as part of our emergency savings, so that we’d be prepared for the unexpected and wouldn’t face extra pressure to take on new debt when, say, our car breaks down. But since most of us don’t use this approach, we are left with this reality: our tax refund is a zero-interest savings account. Now, while that certainly hasn’t been the optimal use of our money, it’s not the end of the world. And for some of us, it might even remove the temptation of spending it throughout the year.
Using the Refund

Once you make the commitment to use the refund efficiently and as a tool to improve your overall financial situation, you need to determine the best place for it, which will depend on a few specifics. The biggest, most important question to ask yourself is whether you have non-mortgage debt. Determining this will help you decide whether to save the money for your future, or use it to pay down a high-interest account that is holding you back. Keep in mind that all non-mortgage debts aren’t created equal, and your situation might lead you to a different process.

The real factor you need to consider is the interest rate of your accounts (we’ve talked before about interest rates and efficiency). If your interest rates are low enough to the point that you can expect better returns from investing, then it might make sense to invest and then pay the minimum payments on the debts. This will most likely be true for consumers with student loans (particularly federal loans) and those with good credit who have low interest loans, like auto loans. Still, paying off the debt will never be a bad thing, and should be an approach you consider strongly. And of course, if you have high-interest debts such as credit cards, you need to work on those as soon as possible.

If the Refund Doesn’t Cover It

If you have non-mortgage debt and the refund doesn’t cover your accounts, you’ll want to make sure that you have a solid plan for managing your money moving forward. As much as possible, you will want to put money toward the account(s) so you can eventually be debt free. Maybe that goal isn’t far off, or maybe it feels like you have a long way to go. Either way, our counselors can review your financial situation and make recommendations about how you can increase income, decrease spending, and make a plan to improve your financial future. If you’d like to learn more, be sure to check out our free budget and credit counseling program.

Thomas Bright is the Digital Marketing & Content Strategist at ClearPoint Credit Counseling Solutions. ClearPoint Credit Counseling Solutions is a member of the National Foundation for Credit Counseling. To schedule an appointment with a Certified Consumer Credit Counselor call 800.750.2227 or visit www.clearpoint.org.

Views expressed are the personal views of the author, and do not represent the views of the National Foundation for Credit Counseling, its employees, its members, or its clients.

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