Here's why you should use your tax refund to pay off credit card debt
If you鈥檝e ever promised to pay off your credit card debt 鈥渨hen you have more money,鈥� now鈥檚 your chance. The Internal Revenue Service聽聽that 70% of taxpayers will get refunds this year. Last year, the average refund was $2,860, according to the IRS.
If you鈥檙e in the red, using the bulk of your tax refund to pay down your high-interest credit card debt can give you some fast financial relief, with almost no effort on your part. Maybe that鈥檚 why the idea is so popular: In a聽2016 National Retail Federation survey, about 39% of American adults said they planned to use their refund to pay down debt.
To be sure, simply paying off聽credit card debt doesn鈥檛聽address the underlying causes of that聽debt, so it might not聽keep you from winding up in the same position down the road. It also isn鈥檛 necessarily everyone鈥檚 No. 1 priority. You may want to spend your refund elsewhere if:
- You don鈥檛 have an emergency fund.听Sock away聽聽in your bank account before tackling your credit card debt.
- Your debt is out of control.听If your debt is more than half your annual income and you see no way to pay it off within five years,聽
- Your credit card debt is interest-free.听If you have debt on a 0% APR credit card, you鈥檒l save more money by tackling higher-interest debts first. Just be sure to pay down your balance聽before the 0% period ends.
But if your credit card debt is gnawing away at your monthly budget, here鈥檚 why tackling it now聽is your best call.
You鈥檒l save money on interest
When you have a mountain of credit card debt, interest charges slowly drain you of cash.
Credit card issuers charged an average annual percentage rate聽of 13.61% on accounts聽that incurred interest聽last quarter, according to the Federal Reserve. At that rate, if you carried an average balance of $5,000 for a full year, you鈥檇 pay聽almost $700 in interest. And since credit cards are open-ended lines of credit, you can carry that debt virtually forever, as long as you keep making the minimum payments. You don鈥檛 want to let that happen.
The easiest way to lower interest聽costs is to transfer your credit card debt to a聽, and doing so is聽a smart idea. But these cards often aren鈥檛 available when you need them most. If your credit is so-so and your debt-to-income ratio is high, you might not be able to qualify for one.
If getting a 0% APR card isn鈥檛 an option, paying down your debt more quickly might be your best bet for saving on interest. Your tax refund can help you do just that.
It could boost your credit
If your credit is a little 鈥渕eh鈥� lately, it might be due in part to all the credit card debt you鈥檙e carrying.
鈥淎mounts owed鈥� 鈥� that is, how high your balances are 鈥� accounts for 30% of your FICO score and is a 鈥渉ighly influential鈥� factor in your聽.听, or the percentage of available credit you鈥檙e using, is a major factor聽in聽amounts owed. As a rule of thumb, it鈥檚 a good idea to keep your balances below 30% of your credit limit at all times. The lower you can keep your balances, the better.
Applying your refund to聽your credit card debt can help you reduce both your overall debt and your credit utilization ratio quickly. This can help your credit score,聽making it easier to qualify for more affordable credit products and even potentially helping you save on聽
It鈥檚 a painless path to a fresh start
Sometimes, the most difficult thing about paying down debt is the 鈥減aying鈥� part.
Because of a psychological effect called聽, losses can聽loom larger in our minds than gains. That鈥檚 why it鈥檚 painful to see money leave your bank account 鈥� even if you know those extra payments are helping you save on interest.
When you pay down your credit card debt with your tax refund check, though, you聽get to pay down that credit card debt with 鈥渇ound money,鈥� instead dipping into your savings. That makes it a little less painful.
It also gives you a chance to build new credit card habits that can make paying a little less daunting. You might decide to make payments on your credit card balance once a week, for example, so it鈥檚 more manageable. Or you could start a new budget to keep your spending down. Wiping out your credit card debt with a tax refund may be a quick fix, but changing these fundamental spending habits can help you save for years to come.
Claire Tsosie is a staff writer at NerdWallet, a personal finance website. Email:claire@nerdwallet.com. Twitter:聽.
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