Finding out that you’ll be receiving a significant tax refund can be exhilarating, especially if you’re living paycheck-to-paycheck or finances are tight. Coming into a good amount of money can get your wheels turning about finally being able to take a vacation, buy a new car, or buy something you’ve always wanted. But if your credit score could use some TLC and spending responsibly hasn’t been your best attribute, consider using your tax refund to set yourself up for future financial success rather than contribute to the cycle of spending and debt.
1. Pay off debt
Your very first priority should be to pay down your debt, especially on revolving credit like credit cards or lines of credit. You want to get your debt utilization ratio down to 30 percent at the most, so check your balances against your total available and do some quick math. If you’re using more than 30 percent of the credit available to you, this has a negative effect on your credit score. Figure out how much you need to pay off to get below 30 percent. Better yet, pay off the whole balance if possible to give yourself a fresh start on responsible spending.
2. Settle Outstanding debts
If you have any accounts that have been sent to collections or are overdue, settle these immediately. Just be aware of the statute of limitations that may restart for a partial payment, allowing borrowers to sue you or collectors to continue contacting you. If possible, make an arrangement for payments or pay of any debts sent to collections in full to rid yourself of the hassle and worry, not to mention boost your credit.
3. Save and Invest
One of the best things you can do to improve your credit over time is to have an emergency savings so that you don’t have to reach for the credit card as often. The goal is to have 6 months worth of expenses saved away, but a good starting point is to have a $1000 emergency fund. Aim for the latter goal, and be diligent not to touch it unless a true emergency arises. This can include car repairs, medical bills, and home repair costs.
Creating or adding contributions to a retirement fund is also a good idea. Retirement may seem far away or even impossible to some based on their current financial situation, but it’s never too late to start saving and planning for the future.
4. Open a secured credit card
Payment history makes up a significant portion of your credit score, so if you need to do some damage control or simply build your credit, consider using part of your refund to open a secured credit card. A secured credit card is much like a debit card or a prepaid card because you first put up the funds you want available on the card, and then use the card to spend the money. The credit card company reports the payments to the credit bureaus like any other credit card, so this is a low-risk, easy way to establish good payment habits and build a history of on-time payments.
5. Analyze your exemptions and deductions
Realize that it’s called a “refund” for a reason – it is your money being given back to you that the government took each month from your paycheck, interest-free. Basically, you gave Uncle Sam an interest-free loan, so a big refund should not necessarily be celebrated. To get more money in your paychecks and have more money to pay your bills, look into claiming more deductions and exemptions to lower the amount of taxes you pay each month.
Use your tax refund to get ahead this year by paying off debt, starting or contributing to a savings or retirement account, opening a secured credit card, and setting yourself up for future savings by analyzing your current deductions and exemptions. Your tax refund can give you the fresh start you need to build your credit and budget responsibly for financial security now and in the future.
Check out our tips and tricks section for more DIY credit repair advice.