Using Your Tax Refund to Pay off Credit Card Debt
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Many Americans receive a tax refund each year, providing a welcome windfall to millions of households each spring. According to the IRS, in 2015, approximately 83% of U.S. tax returns resulted in tax refunds, with an average tax refund amount of $3,120.
Getting a tax refund often feels like “free money” or “extra money,” but in truth, your tax refund is “your money” that you overpaid to the government throughout the year. And getting a tax refund can be a help to your personal finances.
There are a lot of good things to do with your tax refund, and one option is paying off credit card debt, which can have further-reaching benefits.
Here are a few reasons why it’s a good idea to use your tax refund to pay off credit card debt:
High Interest Rate Credit Card Debt Can Get Expensive
If you’re carrying a $15,000 balance on your credit cards and paying just the minimum monthly amount, over time the interest payments will cause you to pay thousands of dollars more than you borrowed in the first place. That’s why, if you use your tax refund money to put a dent in your credit card debt, you can save money in the long run.
You Could Improve Your Credit Utilization Ratio
Your credit utilization rate is the percentage of your available credit that you are actually using. For example, if you have a $10,000 credit limit on your credit card, and you have $5,000 of credit card debt, your credit utilization rate is 50%.
In general, a lower rate is better for your credit score — it shows that you are not using every last available dollar of credit that has been offered to you.
Along with making prompt, on-time payments each month, managing your credit utilization rate can positively impact your credit — and a better credit score can help you save money later by qualifying for lower-interest credit cards and perhaps being able to make a balance transfer to consolidate your debt at a lower interest rate.
Your Tax Refund Can Strategically Help Your Ratio
If you cannot afford to pay off all of your credit card debt, using your tax refund as a one-time source of funds may help you to pay down your debt and reduce your overall credit utilization. This is especially important if you carry balances on multiple credit cards — because in general, if you have a credit utilization ratio of 30% or more, your credit score may suffer.
For example, say you receive a $3,000 tax refund. You have two credit cards: one with a balance of $5,000 on a $10,000 credit limit (50% credit utilization), and one with a balance of $1,000 on a $5,000 credit limit (20% utilization). You could use your $3,000 tax refund to reduce the $5,000 balance to $2,000 — bringing that card’s utilization ratio down to 20%. Even though you didn’t pay anything toward the other card’s $1,000 balance, this move could still help improve your credit utilization rate.
It’s not every day that most people suddenly receive a few “extra” thousand dollars in their bank account — so use your tax refund wisely. Paying off your credit card debt — or even paying down the balances on your cards in a strategic way to improve your credit utilization — is one of the best moves you can make to boost your financial stability.