Benefits Of Using Your Tax Refund Check To Pay Off Your Debt

Camino Financial08 Nov 2023
Using your tax refund to pay off debt is a smart strategy to improve your financial health during the tax season. Because debt can trap individuals in a cycle of neverending interest payments, growing their debt far beyond their initial borrowing amount, it can be a good idea to take any extra money incurred, such as a tax refund, and pay off your debts. This article will explore the benefits of this strategy and how it can help you achieve financial stability.
Table of Contents
1. Can you use your tax refund to pay off loans and credit card debt?
2. Benefits of paying down debt with tax defund checks
4. How paying off debt affects your credit
5. FAQs

Can You Use Your Tax Refund to Pay off Loans and Credit Card Debt?

Yes, you can use the tax refund to pay off debt, including loans and credit card debts! While your tax refund may not be enough to cover a total debt amount in full, you can use it to get ahead in your payments and reduce your total debt.
#DidYouKnow If you file your taxes digitally, you can typically expect your refund within 21 days of filing.

Benefits Of Paying Down Debt With Tax Refund Checks

It Can Save You Money On Interest

Your tax refund may not be enough to cover a loan, but it can still dent the principal amount.
#DidYouKnow Interest payments are one of the biggest contributors to an individual's debt problem.
Whenever you make a payment on a loan, be sure that you are applying the cost to the principal amount and not just the interest. Using your tax refund to pay the principal amount of a loan will save money in interest payments over time.
#DidYouKnow According to the IRS data from the 2019 filing season, the average refund was around $2,725. This number was down from 2018’s average of about $2,833.

It Can Help You Boost Your Credit Score

Did you know that having a 30% or higher credit utilization ratio can seriously hurt your credit score? Credit card debt also affects credit utilization. If an individual isn't paying off their entire balance at the end of the month, their utilization is likely over 30%. It is better to have a very low credit utilization rate and to pay off your credit card balance in full just before the end of the month. A low credit utilization rate will likely result in a higher credit score. Paying off overdue credit card balances can improve your credit utilization rate.

It Allows You To Get Out Of Debt Faster

If you don't have a large amount of debt, using a tax refund to pay off a balance can help you become completely debt free. Paying off debt often results in one less monthly payment, giving you the freedom to pursue other financial goals.

It Helps Improve Your Debt-To-Income Ratio

A bad debt-to-income ratio can negatively impact your credit score. Consequently, a poor credit score can result in higher interest rates and prevent you from getting a loan or a different credit card. Paying off existing debt can improve your debt-to-income ratio and help improve your credit score.

It Can Prevent You From Having To Carry A Balance Past Your Credit Card's 0% APR Introductory Period

Many credit card companies offer a 0% APR introductory period as a bonus for signing up for the card. This encourages many people to sign up for a card and use it without paying off the balance from month to month. After all - if there's no interest, why pay it? This can result in significant credit card bills for many people and exorbitant payments after monthly interest kicks in. Paying off a credit card's balance before the 0% APR introductory period ends is a great way to use your tax refund.

It Can Qualify You For A Balance Transfer Card

A balance transfer card can be an excellent financial choice for individuals with high debt and a high-interest rate card. You can transfer balances from your high-interest account to a low-interest account, saving you money and keeping you from becoming deeper in debt. However, individuals must have excellent credit scores to qualify for a balance transfer card. Using your tax refund to pay off debt on the card you already owe can improve your credit score and make you eligible for a balance transfer card.

It Helps Improve Your Financial Habits

Using your tax refund to pay off debt can help you practice making smart decisions with your money. It can definitely be tempting to take your tax refund and get away for the weekend or buy that expensive purchase you've been eyeing - but intentionally putting money aside is a good financial habit.

It Frees You From The Past

Many Americans become stuck in a debt spiral they feel they can't escape. The best way to use tax refunds is to put your past behind you and begin with a clean financial slate.

It Can Help You Focus On Other Financial Goals

Becoming debt-free is just one step on the journey to total financial freedom. Using your tax refund to pay off any debt, or even reducing the principal amount of just one loan, can help you focus on other financial goals such as savings or investments.

How Paying Off Debt Affects Your Credit

Paying off debt can have varying impacts on your credit score. This is dependent on the type of debt you've paid off. One might expect to pay off a long-standing debt and instantly see their credit score improve. However, that is not always the case. Paying off revolving credit, such as credit card accounts, without closing your account will lower your credit utilization rate and should cause your credit score to improve. But, closing an account such as a mortgage or auto loan may cause your credit score to decrease temporarily. This is because you have decreased your overall credit limit and increased your utilization rate. This is also true if you pay off your lowest balance account and leave the high-balancing accounts. However, even if paying off debt and closing an account may ding your credit score for a bit - you should still aim to be totally debt free. Your credit score will bounce back sometime after closing an account; on average, it can take up to three months. While using your tax refund to pay off your debt may temporarily ding your credit score, it will set you up for success in the long run. If you've been wondering how to spend your tax refund, we hope we've convinced you to invest in your future and become debt-free! Learn how to organize your financial forecasting

FAQs

Does debt affect your tax return?

Not exactly - having debt won't impact your tax return. However, if you borrow money and the lender forgives or cancels your debt, you generally need to include the canceled portion of the debt as part of your income when filing your taxes.

Can debt collectors take your tax refund?

Credit card lenders, as private debtors, cannot directly garnish your tax refund. However, if they are collecting a debt from you and garnishing your accounts, they could potentially take a portion of your tax return as garnishment after the IRS deposits it into your bank account.

Can I write off credit card debt on my taxes?

Credit card debt and credit card interest for personal purchases are not tax-deductible. However, the interest on a business loan may be refundable.

What kind of debt can you pay with a tax refund?

You can use the money from a tax refund to pay any type of debt.

Should you use your tax refund to pay off debt?

It is an option! Many businesses have immediate operating expenses that take precedence over paying off debt. However, if your business is not in emergency need, it may be beneficial for you to use your tax refund to pay off your current debt.

What debt can the government use your tax refund to pay?

The federal government can garnish tax returns in the cases of:
  • overdue federal income taxes
  • overdue state income taxes
  • abundant unemployment compensation
  • defaulted federal student loans
  • overdue child support
  • overdue spousal support

What to do with your tax return?

A tax return is an excellent opportunity to make the most of your money and secure your financial future. The best approach is to use your tax return to start repaying your debt, especially if they are overdue. You can also put the money aside in an emergency fund which will provide extra security if an unexpected expense arises or if you find yourself suddenly unemployed. Consider investing some or all of that money into investments such as stocks and bonds or mutual funds that could yield greater returns over time than saving it in a traditional bank account over long periods (however, this comes with risks).

Can the IRS take your tax refund to pay for overdue debt?

The federal government prohibits the IRS from holding tax returns for any purpose other than overdue federal and state income taxes. Also, for abundant unemployment compensation, defaulted federal student loans, overdue child support, and overdue spousal support.

What should I use my tax refund for?

You can use these for anything you like. However, people interested in pursuing financial freedom might use their tax refund to pay off debts.

Can I use my tax refund to pay off my car?

Yes, you can use tax refunds for anything, including settling an existing loan balance on a vehicle.

What is the best way to spend tax refunds?

It will depend on the size of your refund and what you need financially. If you have high-interest debt, such as a business loan debt, paying off this debt should be the top priority. Doing so can help reduce the interest you pay and improve your credit score in the long run. Furthermore, eliminating some or all of this type of debt can free up more funds for other expenses in the future since you won't have those payments eating into your budget each month.

What are other financially savvy ways to spend your tax refund?

You can use tax refunds to:
  • Create an emergency fund
  • Build an investment portfolio
  • Collect interest in a high-yield savings account
  • Improve your personal finances by padding your retirement savings

What's the average tax refund?

The average American's tax refund is around $3,000. When a tax return is much larger than $3,000, it becomes even more critical to make a smart choice with the refund.
 

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