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According to the IRS, the average tax refund paid out in 2021 was around $2,815. This can make a major dent when it comes to buying a new car — or even paying off your current auto loan. If you expect a similarly sized refund, plan for how you can best take advantage of a few thousand extra in your pocket.
3 ways to use your tax refund to pay for a car
There are a few ways you can make the most of your tax refund to get on the road. Depending on your current financial situation, determine which route is best for you and your wallet.
1. Pay down your current loan
Although this will mean no new car smell or set of wheels in your driveway, paying down your current loan can be a very financially wise decision. Use your tax refund to either make a few additional payments or pay the entire balance in full. But before you use your refund to pay down your loan, check the fine print on your loan agreement to avoid any potential early payment fees.
Be aware that by the tail end of your loan, you are usually not paying interest anymore, just the remaining principal. For that reason, it may make financial sense to put your refund to use elsewhere if you don’t have much of a balance left.
2. Make a down payment on a vehicle
The higher your down payment is on your vehicle, the lower your monthly cost and the less interest you will pay over time. It is recommended you have 20 percent of the vehicle’s value as a down payment, so using your tax refund to make a large down payment on a vehicle is a great way to pay less overall.
A down payment calculator will help you see how much money you can save. However, this strategy is only effective on its own if you expect a large tax refund. Otherwise, you should still use your trade-in and savings to cover the full 20 percent down payment.
3. Lease a new vehicle
Leasing a vehicle allows those who want to get behind a newer, nicer vehicle to do so at a lower cost than buying. With more money at your disposal, you can pay more up front for the vehicle to your monthly cost.
But a down payment isn’t usually recommended on a leased vehicle unless you need to lower the monthly payment. This is because the overall cost is the same — and you will be out that money if the car gets totaled.
Although there are many perks to leasing — the newest technology, ability to drive different vehicles — be sure to consider both the benefits and drawbacks of leasing before signing off.
Tips on using your tax refund wisely
Consider these tips after your return arrives in the mail or is deposited into your bank account.
- Don’t let the dealer know about it. Although it is exciting to receive some extra cash through the refund process, do not publicize it when at the lot. This could potentially throw away any chance for effective negotiation.
- Keep your budget in mind. The additional money you have received will not last forever, so don’t get carried away and disregard any budget you typically follow. This is especially important when it comes to vehicle financing. Be sure you sign off on a loan that you can still afford as the months carry on.
- Don’t rush the process. If a new vehicle is in your future, determine what vehicle you want and which financing option will save you money before tax season ends. That way once you receive your check, you won’t feel pressured to make a large financial decision on a whim.
- Consider buying used. A new car does not have to be “new.” To make the most out of your refund, consider a less expensive used vehicle. Your tax refund will stretch further, and you will be able to borrow less.
For most Americans, tax season can be stressful. But if you take the time to plan you can get the most out of your refund and maybe even drive off with a new car. And remember, taxes are due in mid-April — right around Memorial Day, which may give you a chance to land a better deal.