Using a Tax Refund to Zap Your Card Balance
By Erica Sandberg
October 23, 2012
I am getting a tax refund of just over $3,000 this year. I owe $5,000 to my credit cards. Should I use the money to pay my balance and still have $2,000 left and no savings? Or should I keep the $3,000 in savings for emergencies as everyone says and pay off my credit card company by making payments? Thanks for your advice. –– Ryan
Ah, it’s nearing that time of year again when the tax questions start flying. In the end, some will owe the IRS (yikes), others will break even (yay) and the rest are sure to get some cash back (yay, in a way).
Of course, a big check feels like a windfall, but consider this: $3,000 divided by 12 is $250. Could you have used such a sum in your daily life — either for paying regular bills or for establishing a savings account that you could have dipped into for unexpected expenses and fun? The answer, I’m sure, is a resounding yes.
In fact, I would be willing to bet that at least a portion of the credit card debt that you’ve got right now is a result of you being short of funds at the end of the month. If you had a couple hundred dollars more in your checking account, you might have been able to make ends meet without having to charge the difference.
Now that you do have some money to work with, though, here’s what I think you should do:
- Put $1,000 into a savings account. There is nothing like building a savings account to make you feel secure and confident that you’re on your way to living in the black. A large deposit is the way to go, and yes, some can be used for crisis situations like higher-than-anticipated car repairs or a sudden job loss. Still, be really careful when tapping those funds. Consider them sacred for as long as possible.
- Use $2,000 to pay down a portion of your debt. While you won’t be entirely free of the balance, you will make a significant dent in it. That, too, will provide a valuable sense of doing the right thing. Oh, and it will also reduce the amount you’re paying in interest charges.
- Clear the remaining balance in six months at most. With $3,000 still owed, you want to get that balance down to zero quickly. Credit card debt should not be a long-term obligation. In general, you’ll always want to repay the balance within a few months. So here’s your chance to get into that habit. To be in the clear in six months, make regular payments of $530 (I assumed a 17 percent APR). Pay more when you can, and do not charge a penny for the time being.
- Add the previous debt payments to your savings account. When you’re debt-free, immediately begin to deposit the money that you had been sending creditors into your savings account. In a year’s time you will accumulate around $7,000 (that includes the grand you’ve already set aside). Wouldn’t that be sweet?
- Don’t build up a credit card balance again. Hey, everyone makes mistakes and charging more than you can afford to repay quickly is a common one. But now you know what that’s like, and it’s not pleasant. So make a pledge to change the way you borrow. Go ahead and swipe your card, but pay in full and on time. You know the drill. Now do it.
And finally, for next year, I suggest a heart-to-heart with a tax adviser. Discuss ways you can have as much of your income in your pocket as possible without having to cut a check to Uncle Sam.
Got a question for Erica? Send her an email.