4 Mistakes You May Be Making With Your Tax Refund When You Have Debt
Got debt? Thinking of using your tax refund check to play catch up or pay down a balance? Before you act, read this article. Most people who have debt make the wrong choices with their tax refunds. End result: you wind up even more stressed than before you got your refund check. Here are the most common mistakes folks make with their tax refunds — and some suggestions for what might be a better option in your situation.
1. Paying down a large chunk on a debt to reduce the balance. This only makes sense if you already have a savings cushion. Without savings, you’re more likely to rack up the same debt on the same credit card when an emergency happens.
Better: continue to pay the minimum payments each month and set aside the tax refund check to use when emergencies arise. The first step to breaking the debt cycle is to stop adding any new debt.
2. Using the money to “reward” yourself for all the months you’ve gone without. Emotional spending is a lot like emotional eating. Are you’re a binge spender, or do you tend to spend your tax refund on a big ticket item every year? If so, you’ve created a habit of spending to get yourself back into your “comfort zone”. Getting any amount of money that’s larger than what you normally have sends your financial neurons into overdrive. Your mind will do everything possible to get you back into your financial comfort zone — that familiar place of struggle, worry, and scraping by.
Better: Take your financial comfort zone up a notch by putting your tax refund in time out. Stick the refund check in a 30-day CD. This will give you a cooling off period to rethink any impulse purchases and plan a strategy for building savings and paying down your debt. Doing something different this year can snowball into a higher net worth every year.
3. Using your tax refund to “catch up” on past due bills like credit cards, medical bills and the mortgage. Already seriously past due on your credit card or medical bills, or facing foreclosure?
Better: If you don’t have the income to currently pay your daily living expenses, you may want to think twice before you decide to pay off overdue bills. It may be time to make some hard decisions. Consider using your tax refund to hire a quality bankruptcy attorney or debt negotiator, or put the money toward moving expenses.
4. Tossing tax refund money toward the creditor who is yelling the loudest.Creditors have their best interest in mind, not yours. Only if the creditor is “important” to your daily living does it make sense to use your tax refund to get current. This includes paying your rent/mortgage (if you have the means to keep current after you catch up), your car or health insurance, utilities or car payment.
Better: If you know you can’t truly afford to keep paying your housing costs, or if the squawking creditor is unsecured, use your tax refund to pay your car or health insurance premiums for the full year, instead of just paying the monthly amount due. Or use your refund check to pay extra principle on your car payments, so the loan ends faster. Actions like these take care of essential bills and free up more of your monthly income. You can then use the extra monthly income to pay unsecured creditors on a schedule that honors your family’s daily financial needs.
These days, it’s vital that you take a minute to figure out how much good your refund REALLY will do if you put it toward your debts or use it for a large purchase. You want your tax refund to create long-term change and financial healing, not just stop the bleeding! I encourage you to crate a strategy that will improve your family’s financial life from this day forward.