Why You Should Use Your Tax Refund to Pay Off Debt

By by Benjamin Feldman, Writer & Content Strategy


With the New Year comes the beginning of tax season, and that means people are starting to think about what to do with their tax refunds. While it may be tempting to take a shopping spree or a vacation, you’ll be much happier in the long run if you use your tax refund to secure your finances. A new outfit might make you happy today, but a healthy savings account will make you happy tomorrow! If you have debt, it’s even more important to use your tax refund strategically, because your debt not only prevents you from pursuing wealth-building financial options, it also costs you money.

Use the math to your advantage

If you take a hard look at the math involved, you’ll realize just how bad it is to carry debt. Many people have credit card debt with interest rates in the range of 15% to 25%. That means if you have $4,000 in debt, you could be paying as much as $1,000 per year in interest! Other types of debt are not much better -- even student loan debt often has interest rates as high as 6-8%.

The problem with paying interest is that it puts you on the wrong side of the math. Compound interest, one of the most powerful forces in the world, means if you pay $1,000 of interest (as in the example above), you’ll soon be charged interest on that $1,000 -- and you’ll continue to be charged interest on it until you pay off the balance. The debt can pile up quite rapidly for this reason. 

On the other hand, if you have money in savings, you are the one who gets to earn interest. The bank pays you interest, which then compounds. So if you earn $100 in interest on the money in your savings account, you’ll begin earning interest on that amount immediately. This is how a lot of people build their retirement funds -- by relying on compound interest to build wealth for them!

Set yourself up for future financial stability

Not only does debt cost you money, but it puts you in a precarious position. Life has a tendency to throw unexpected circumstances in our path, and when those things happen we need to have as much flexibility as possible to respond in an appropriate way. If your car were to break down, if you were to lose your job, or if you were to have a medical emergency, what would you do? Would you have the financial leeway to respond? 

Instead of continuing to carry debt or using alternate debt relief methods, you’ll be much happier if you begin building a solid foundation for your finances. And that starts with using your tax refund to pay off debt. In fact, you could potentially use your tax refund as a springboard to becoming completely debt free in 2014! The hardest part of paying off your debt is just getting started, so using this as an opportunity to jumpstart your 2014 “debt free” New Year’s resolution would make a lot of sense.

Once you become debt free, you will be able to start building up your positive net worth. And it’s a great feeling when your bank account finally goes from negative to positive! You’ll enjoy seeing the savings pile up, month after month.

More importantly, you’ll be able to pursue your other long-term goals. Whether you want to apply for a mortgage someday, make a career change, send your kids to college, or something else entirely, you’ll be able to do it if you build that solid foundation first. And it all starts with your tax refund that will help you transition from the “indebted life” to the “saver life.”

Tip of the Day

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