Should I Use My Tax refund to Pay Off a Credit Card Debt?

If you have read enough overly simplistic newspaper and magazine articles on this subject, you will certainly know at least one of the answers to this question already! The standard answer is, of course, that you should put any spare cash on your credit card, always keep them for emergencies only, and pay everything off in full before the end of your interest-free period.

However!

For those of us that live in the real world, the answer is not always that simple. Today we look at the upsides and downsides of using your tax return to pay off your credit card debt.

Net savings

This is the biggest and most obvious benefit of using your tax refund to pay down your credit card debt. When all is said and done, it costs you less money to simply pay down a credit card debt, than to keep it going and start an emergency fund.

The other side

If you are currently overextended in terms of your credit limits, you may find that you pay down your credit card debt, only to have your limit lowered by the bank. Then you have no tax refund, and no leeway on your credit card … and no funds in case of emergency. Depending on whether the bank will reduce your limit when you pay off some of your debt, you should consider splitting up your tax refund between debt and savings.

If you were going to spend on your card anyway…

If you have a large purchase coming up which you would have had to use your credit card for (dentist bills, fixing the car, replacing a broken TV, taking a very well-deserved vacation), you should simply use your tax refund to pay it instead.

New debts versus old debts

If you have a large credit card debt, paying money off it will usually pay down your most recent debts first – the ones that are still within their interest free period. So, paying off only the recently charged portion of your credit card might not make a difference to your total interest.

However, if you haven’t charged much recently, you could pay down your debt, and know that anything you need to charge in the near future will be interest-free for 55 days, or whatever the term of your individual card is.

Note: If your tax refund is substantial (usually more than around $4000), you should look at paying less tax if possible. If you are able to get that money spread out over the year, you’ll be in a better position to manage your expenses … which after all, are mostly weekly rather than yearly.