The average income tax refund issued so far in 2021 is $2,880 – down 7.8% from the 2020 average of $3,125. That’s still no small amount! What will you do with your 2021 income tax refund? Maybe your refund is earmarked to pay for essentials this year. It was a rough 2020. But if you don’t need it for essentials, here are three reasons why you can’t go wrong using your tax refund to pay off debt.
Instant Return on Investment
Suppose you are receiving a tax refund of $3,000 this year. There are many things you could do with such riches. Why choose to use your tax refund to pay off debts? Because you get an instant return on investment. For example, you have a $5,000 debt on a credit card that charges 18% interest. Maybe you are struggling to make the minimum monthly payment. In that case you are hardly making a dent in the principle amount borrowed. Plunking down a $3,000 payment on your card will save you approximately $540 in interest the very first year. Compare that 18% savings to the average savings account interest rate of 0.07%. Or even the average 10% annual return of the US stock market. When you pay off debt this is a guaranteed return. For each dollar you pay off, you will never pay interest on it again for the entirety of your loan.
Using your tax refund to pay off debts may provide budget flexibility. If you have a $5,000 credit card debt, your expected monthly minimum payment is about $175. If you use your $3,000 income tax refund to pay down the account, your new minimum monthly payment should be about $70. You will provide yourself about $100 per month in budget flexibility. You are then able to spend that $100 on another financial priority. However, it may be best if you could still make the $175 per month payment to supercharge your debt repayment and achieve debt-free status even sooner.
Build Your Credit Rating
Did you know that 30% of your FICO Credit Score calculation is influenced by the amount of debt you maintain? Next to paying your bills on time, reducing the total amount you owe is the best way to build your credit reputation. Lowering your total debt improves your credit utilization ratio. The credit utilization ratio is the percentage of a borrower’s total available credit that is currently being used. Using your tax refund to pay off debts could result in better lending offers on a future car or home purchase. This could save you thousands of dollars over the course of these installment loans.
Your Best Next Step
Still not sure if using your tax refund to pay off debt is your best choice? You can reach out to a certified non-profit Financial Services Specialist for advice: 800-355-2227 or online for free financial analysis and a custom action plan.
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