So you expect a tax refund this year. Due to inflation, which increases the prices of gas, food and almost everything else, this extra money may not come fast enough. The most difficult thing is to decide how to spend it. Is it worth investing money? Book a trip?
If you really want to do yourself a favor, use a refund to repay the debt. That’s why.
YOU SAVE ON LETTERS
“The cost of debt is very expensive,” says Anna Marie Mock, a certified financial planner with Highland Financial Advisors in Wayne, New Jersey. “Especially when you look at ordinary consumer debt, such as credit cards, (the interest rate) can be north of 16%.”
Issuers charge higher rates, often well over 20%, depending on the type of card or user’s credit account.
Let’s say you’re trying to repay a $ 6,000 credit card debt with an interest rate of 19% by paying $ 200 a month. You will pay $ 2,204 in total interest until your credit card is repaid. Here’s how using a tax refund can reduce those costs: if you get a $ 1,500 refund and deposit the entire amount on your balance and then continue to make the same monthly payment, the total interest you pay will drop to $ 1,107. You also write off the debt a year earlier.
Due to the increase in interest rates on federal funds of the Federal Reserve in March, as well as an additional increase expected at the end of this year, the debt is becoming even more expensive. Most credit card rates are variable, and issuers are likely to raise them in response to Fed action. Pay more or the entire balance now to avoid overspending on interest.
What if you have multiple debts? First speeding up payments on the account with the highest interest rate and then moving on to the next highest (a strategy known as a debt avalanche) is usually the fastest and cheapest way to get rid of debt. You can use a debt repayment calculator to estimate how different rates and payment strategies will affect the amount you owe.
YOU CAN BUILD YOUR CREDIT BANK
The use of your credit or the percentage of your credit limits that you use are an important factor in your credit rating. Using a tax refund to reduce your balance helps reduce the use of credit, which can benefit your account.
“The higher our credit score, the lower the price of a lifetime,” says Tina Herndon, financial education and training manager at Balance, a nonprofit financial education and consulting organization based in Concord, California.
Debt repayment could go ahead in the long run, she says, opening the door to more affordable loans. “If you can pay 2.9% interest on a $ 25,000 car versus 21% interest, it will save you hundreds of dollars a month,” Herndan says.
Drastic changes in credit will not happen overnight, and there are other factors that shape your score. But repaying debt at a high rate is an important step in the right direction. And less debt compared to your income can improve your chances of getting a new loan.
THIS MAY BE YOUR MOTIVATION
Debt can be an “obstacle that people need to overcome mentally before they can potentially move on to the next stage to start saving to achieve goals,” says Mock.
Make a list of your financial goals. Maybe you want to buy a house or send your child to college. Debt elimination can bring you closer to reaching these stages.
Perhaps your goal is to get rid of debt. Even if your return is not enough to destroy your debt right away, watching your balance drop can build up the momentum you need in order to keep beating it off.
YOU DON’T NEED TO ENJOY FUN
Using a refund to repay a debt doesn’t mean there’s no room for fun shopping. In fact, by reducing your debt, you will have more money to do what you enjoy. Once you pay the bills, you can take the amount spent on the payment and send it to something that brings you joy. For example, increase your entertainment budget or run a leisure fund.
But if you don’t want to wait, go and treat yourself now. Herndan proposes to allocate a certain percentage or amount in dollars in the “entertainment category”. If you get a $ 2,000 refund, you can set aside 10% or $ 200 for a visit to the spa or for new headphones.
“It’s all about moderation and the belief that you’re thinking about compromises so you don’t owe everything,” Mock says.
This article was provided by The Associated Press on the NerdWallet personal finance website. Lauren Schwan is a writer at NerdWallet. Email: firstname.lastname@example.org. Twitter: @lauren_schwahn.
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