If you are expecting, or recently received, a tax refund, consider using it to strengthen your personal balance sheet rather than spending it. Here are six smart uses for your refund.
Pay Off Credit Card & High-Interest Debt
The average US household with debt has over $16,000 in credit card balances with an average Annual Percentage Rate (APR) over 15.00%. If you’re currently only making the minimum payments on a $16,000 balance, making a one-time $3,000 payment would save more than $3,000 in interest and shave well over a year off the payoff date. Using your refund to pay off or pay down credit card debt is like earning 15.00% on an investment (depending on your APR). That is an incredibly valuable use of your money!
Start or Rebuild Your Emergency Fund
If you don’t have any credit card debt, the next best option is assessing your savings. Nothing can derail your financial plans more than having inadequate cash reserves when you need them. Those who are unprepared for an unexpected job loss or expenses are then forced to borrow at high interest rates or liquidate other investment assets at inappropriate times. Sadly, 25% of Americans have no money saved for emergencies according to Bankrate.com. Your goal should be to have at least 3-6 months of expenses saved in your emergency fund, and this money should be easily accessible in a money-market or savings account. An Emergency Fund is a vital piece to your financial security and is definitely a smart use of your tax refund.
Use it for a Down Payment on a Home
A down payment on a mortgage can be a significant obstacle to overcome when buying a home. If you receive a tax refund, and you’re in the market for a new home, this is a great opportunity to get pre-qualified (if you haven’t done so already) and earmark those funds for your down payment. Depending on the price of the home and loan program you choose, it’s possible that a tax refund could even make up the entire down payment!
Make Extra Principal or Interest Payment on Your Mortgage
If you’re not in the market for a new home, paying off your existing home early is another way to save money in the future. Paying off your mortgage may seem far away — 15 or even 30 years. However, did you know that simply making one extra principal and interest payment each year will take years off of your mortgage and save you a substantial amount of interest? For example, if you have a $150,000 loan at 4.5% for 30 years, your principal and interest payment will be around $760. If you pay an additional $760 once a year each year, you will pay your mortgage off in 25.5 years rather than 30 — and save over $21,000 in interest! Or if you just pay an extra $100/month for a total of $1,200 per year for the life of your mortgage it will be paid off in 23.6 years and you will save almost $30,000 in interest.
Boost Your Retirement Savings
If you don’t have substantial credit card debt and you have an emergency fund, you’re doing well! A Roth Individual Retirement Account (IRA) allows you to put money away that will grow to be tax-free after age 59 ½ (as long as the account has been open for 5 years). If you contributed $3,000 today and continue to invest your $3,000 tax return each year, assuming the account earns 7% annually, your IRA will be worth over $140,000 tax free in 20 years. One great benefit is that in the meantime your contributions are still accessible. If you need to withdraw them early you can without paying a penalty. The earnings may be subject to taxes and penalty if withdrawn before attaining age 59 ½ (exceptions include when the earnings are used for education expenses or a first-time home purchase).
Put it to Work for You With a CD
With interest rates on the rise, putting your money into a Certificate of Deposit (CD) might be a good option for you. Terms typically range from 3 months to 60 months or more, so you can choose the length of time – and corresponding rate – that suits you best.