Dear Debt Adviser,
I will be receiving a tax refund of $5,000 or so this year and was wondering how best to use the money. I have about $7,000 in credit card debt, two car loans, and my son will be attending college in the fall. Should I pay down some debt, or should I save the tax refund to help pay my son’s tuition?
To make the most of your tax refund, I want you to take a few minutes and think about your entire financial situation — not just the issues that are the top of mind at the moment. Here are some questions to consider:
- Are you current with all of your monthly obligations? If not, catching up any late payments should be your first priority.
- If your child is old enough to go to college, you are old enough to be concerned about retirement planning. Are you making regular contributions to a retirement fund? You may consider adding at least a portion of your refund to your retirement account.
- Have you been putting off home repairs or maintenance? You can save a lot of money and frustration by getting ahead of potential problems like a leaky roof or an old heating system. Investing in your home may be a good use for your refund.
If you’re comfortable that all or part of the refund isn’t needed elsewhere, my suggestion is to use your refund in this order:
- Concentrate first on any high-interest credit card debt. This will save you money on your payments and cost you less for interest on new purchases added to your balance. New purchases accrue interest from the day of purchase.
- Next, focus on your car loans. The sooner you pay off your cars, the sooner you can reallocate those monthly payments to other priorities.
- Last in my ranking are your son’s loans. Low and possibly deferred interest on what may be a 20-year obligation, or more, make this loan the least troublesome to manage.
Now, let’s talk about what to do next year. A refund of $5,000 means you loaned the IRS money during the year. If this is not just a one-time windfall, consider changing your withholding for this year and keep more of your paycheck. Put the extra money automatically into savings or use it to pay cash for some items instead of using your credit card and paying more in interest in 2014.
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