While most people don’t enjoy doing their taxes, a healthy tax refund can be a good consolation prize. For many people, a tax refund is the biggest windfall they receive each year. And it can be a significant chunk of change: the average tax refund in 2022 was about $3,000. After months of painstakingly chipping away at your credit card debt, a tax refund of that size feels like a gift sent to supercharge your progress. It’s tempting to immediately put that money toward your balances, but it might not be your best financial move in the long run. Here are a few signs that you should pause and think before paying down your debt:
You Don’t Have Any Emergency Savings
If your ultimate goal is to get out of debt and stay out, you need an emergency fund. This spare cash keeps you from going further into debt when unexpected expenses pop up. It also keeps you from going back into debt once you get out. If you don’t have an emergency fund, this is a great opportunity to open a high yield savings account and kickstart it with your tax refund.
You Have Big Upcoming Expenses to Pay
With your tax refund in hand, it is easy to imagine the immediate satisfaction that you’ll get by throwing it all toward debt. But do you know what is just as satisfying, if not more so? Feeling prepared for upcoming expenses! Maybe you have a vacation planned in the next few months that you haven’t started saving for or you need to replace the tires on your car soon. If you don’t have money set aside for these expenses, they will likely end up on your credit card. So rather than put all of your refund toward debt, save the money that you will need for these known expenses. If there is any left after that, you can pay that on your debt and feel secure in the knowledge that that amount is truly getting you closer to becoming debt-free. And when the bill comes due for your vacation or tires, you’ll feel great knowing that you planned in advance.
You Haven’t Addressed the Underlying Reasons for Your Debt
If you haven’t identified what is contributing to your debt and started taking steps to make changes, using your tax refund to pay down debt will provide only temporary relief. You don’t have to be perfect but you should have started to make a concerted effort to change the patterns and habits that caused your debt to accumulate. If you haven’t, there is a good chance that your balances are likely to creep back up and leave you even more discouraged than before. Instead, stash that money in savings for now while you get started on the internal work. You can always use it to pay down debt in the future once you feel more confident that it will make a lasting difference.
Final Thoughts
Even if you have eye-popping interest rates on your credit cards, don’t automatically assume that using your whole tax refund to pay down debt is the best financial move for you. Yes, it will save you money on interest, but it might actually make it harder for you to get out of debt and stay out of debt. So when the juicy refund comes in, consider sticking some of it in savings first!
