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Two-thirds (66.6%) of all Americans will receive, or have already received, a federal tax refund this year. That number is up 1% from last year, in spite of the tax law changes that provided fewer deductions for many Americans and no first-time home buyer tax credit.
What are most Americans doing with the money? The National Retail Federation conducts a survey every year to reveal just that. The 2011 findings:
- 42.1% will save the money (up from 40.3% last year)
- 41.9% will pay down debt
- 29.7% will use the money on everyday expenses
- 13.2% will buy a big ticket item
- 11.9% will pay for a vacation
If you are among the 41.9% percent who intend to use the money to pay down debt, you may be wondering where, exactly, to put the money. Here are our suggestions:
Pay Off Revolving (Credit Card) Debt
By far, paying off a credit card, or several credit cards, is the wisest way to spend that tax refund if your goal is to get out of debt faster. You can chip away at multiple credit cards with small balances using the “snowball” method to pay off debt, or tackle your highest interest card using the debt stacking method to pay off your credit card debt. If you pay off a lot of cards with smaller balances, you’ll have less bills to remember to pay each month. But if you pay off your highest interest card, you’ll save more money in the long run.
If your goal is raising your credit score and you can’t quite pay off any credit cards in full, you may consider allocating the money (if possible) so that no single credit card has a balance greater than 50% of your available credit.
Make an Extra Mortgage Payment
If you’re looking to save the most money by paying down debt, using your income tax refund to make an extra payment to your mortgage can save you tens of thousands of dollars. You can use a mortgage amortization calculator to figure out exactly how much cash you’ll save with an extra mortgage payment at your current interest rate.
Here’s an example:
You have a $200,000 mortgage at an interest rate of 6.5%, making your mortgage payment $1264 per month for 30 years. By paying an extra $1264 every year, you’ll save approximately $56,000 in interest over the life of your loan and shave a full six years off your mortgage.
Very few other debt payoffs can save you this much money in the long term, and you’ll also be building equity faster in your home, which would be a benefit if you decide to sell, refinance, or take out a home equity loan.
Pay Off a Zero Percent Financing Offer
What if you don’t have a lot of revolving debt, and don’t own a home or don’t have a mortgage? Why not pay off a zero percent financing offer before the introductory period ends?
The 0% interest credit card isn’t costing you any money directly, but carrying a balance is raising your debt-to-available credit ratio, which is hurting your credit score. If paying off that credit card would raise your FICO score up by a tier (say, from good to excellent), it’s the smartest move for your financial future.
You could realize substantial savings in car insurance and also open yourself up to great offers for rewards credit cards so you’ll earn up to 5% cash back throughout the year. You won’t find a savings account with a 5%, or even a 2%, yield.
You can check your credit score for free at CreditSesame, or even use the Quizzle.com Credit Personal Trainer, or CreditKarma.com’s debt simulator to decide if this is the wisest move. As long as you have emergency savings in the bank and no other debt, it could be the wisest way to spend your money.
How are you spending your income tax refund this year?