This article is reprinted by permission from NerdWallet.
So you’re expecting a tax refund this year. With inflation driving up the price of gas, food and nearly everything else, that extra money can’t come soon enough. The hard part is deciding how to spend it. Should you invest the money? Book a trip?
If you really want to do yourself a favor, use your refund to pay off debt. Here’s why.
You’ll save on interest
“The cost of carrying debt is very expensive,” says AnnaMarie Mock, a certified financial planner with Highland Financial Advisors in Wayne, New Jersey. “Especially if you’re looking at regular consumer debt, like credit cards, [the interest rate] could be north of 16%.”
Issuers do charge higher rates, often well past 20%, depending on the type of card or the user’s credit score.
Let’s say you’re trying to pay off $6,000 in credit card debt on a card with a 19% interest rate by paying $200 a month. You’ll pay $2,204 in total interest by the time the credit card is paid off. Here’s how using a tax refund could reduce that cost: If you receive a $1,500 refund and put the full amount toward the balance, then continue making the same monthly payment, the total interest you pay would drop to $1,107. You’d also wipe out the debt a year sooner.
With the Federal Reserve’s federal funds interest rate hike in March, plus additional hikes expected later this year, debt is getting even more expensive. Most credit card rates are variable, and issuers will likely raise them in response to the Fed’s actions. Pay off more, or all, of your balance now to avoid overspending on interest.
What if you have multiple debts? Accelerating payments on the account with the highest interest rate first, then moving on to the next highest (a strategy known as debt avalanche), is generally the quickest and cheapest way to become debt-free. You can use a debt payoff calculator to estimate how different rates and payment strategies will impact…