How to Use Your Tax Refund to Improve Your Credit Score
If you’re expecting a big tax refund from Uncle Sam, it might be tempting to spend that money on a vacation, a better TV or a down payment on a new car.
Through the middle of October 2018, the IRS processed more than 110 million total refunds, averaging $2,825, according to 2018 filing season statistics.
Like any windfall, that money can also be used to benefit your long-term financial health. Using your tax refund to improve your credit score could be the smartest financial decision you make all year. You just need to know where to start.
5 steps to improve your credit score with a tax refund
1. Catch up on late payments
Thirty-five percent of your credit score is based on your payment history. If you have a credit card, mortgage or auto loan payment that is past due, why not use the money from your tax refund to catch up?
In fact, according to a December 2018 study published by LendingTree, many people catch up with their bills in April — tax refund time. And credit rating agencies will tell you themselves: Late payments are a recipe for trouble and can damage your credit score.
“You’ve proven you can handle your credit, and all of a sudden you’ve got a blip,” said Richard Westbrook, consumer chief credit officer at Columbia, S.C.-based South State Bank. Let those blips add up, and you could find yourself in real trouble.
2. Get a secured credit card
If you’ve had credit problems in the past, a secured credit card is a great way to get back on track. With a secured card, you make an upfront deposit, and your credit limit can be equal to the money you put down. It guarantees that you can’t spend more than you have, while still letting you build a record of responsible spending.
Using all or part of your tax refund to open a secured credit card lets you simultaneously spend your money and build up your credit score.
3. Reduce credit card debt
Thirty percent of your credit score is based on how much you owe. The lower your credit utilization, or the ratio of your credit limit to how much you actually owe, the higher your score could be. Using your tax refund to pay off credit card or other debt can help ease the pressure on your finances and better prepare you for future rough patches.
“Using that money to pay down credit card debt, and therefore result in a higher credit score, is the best advice that you’re going to get,” said Atlanta-based credit expert John Ulzheimer, formerly of FICO and Equifax.
If you have multiple debts and are unsure which to pay off first, going after the debt with the highest interest rate and highest APR first should have the most impact.
4. Bulk up your savings
Putting even part of your refund into a savings account can help your credit score by giving you a cushion the next time unexpected expenses arise. Start small — even $500 is a step in the right direction.
Smart About Money, a program of the National Endowment for Financial Education, an independent nonprofit foundation, suggests having an emergency fund equal to three to six months of living expenses. That can seem like a big hill to climb when starting from scratch, which is why your tax refund is a great opportunity to kickstart it.
5. Adjust tax withholdings to potentially avoid future debt
Getting a refund feels great, but it might also mean you need to talk to your employer about adjusting your tax withholdings. If you’re consistently getting back large sums from the IRS every year, you should probably be getting that money in your paycheck instead.
Having that money on hand throughout the year could prevent you from having to run up debt in the first place.
Don’t spend your tax refund before you have it — and be smart
Whatever you plan to do with your refund, hold off until the funds are safely deposited in your account. Don’t take out a refund-anticipation loan just to get the money ahead of time. If you do, you could find yourself paying interest and fees on the loan, which could put you right back in the red.
If you’re one of the lucky people expecting a refund this year, be smart about it. Pay down your student loan. Pay off collections. Start a savings account for future emergencies. Even consider making an extra mortgage payment. (It won’t help your credit score, but it will save you money in the long run.)
Remember, a tax refund isn’t found money. It’s money you earned by working, and you should to treat it with the same respect that you do your paycheck. The temptation to spend it on simple pleasures will always be there. But using it to help improve your credit score can have positive ramifications that will last far longer than any vacation.