Should I use my tax refund to pay off my car loan and credit card debt?

What’s the smart thing to do with your tax return? Should you save your refund for a future emergency? Should you use your tax return to pay off debt? For most of us, tax season signals the impending arrival of some so-called extra money. While it’s not free money—it’s actual earnings on which you overpaid taxes, essentially giving your government an interest-free loan—many people wind up with a few hundred bucks (more, if you’d waaaaay overpaid your income tax in the preceding year). Before you start dreaming up ways to spend that cash, let’s consider some smart things you can do with that payout.

Auto loans and mortgages are types of installment loan agreements in which the consumer purchases something, and the debt is specifically tied to that item (e.g., a vehicle). Credit-scoring algorithms understand that your debt-to-credit–limit ratio could be high on these types of loans, and that consumers usually stay current on these accounts to avoid having the asset repossessed. Of course, if you miss a payment, there will be a resulting negative affect on your credit score.

Paying off an installment loan may positively impact your score a little, but the consistency of paying an installment debt does more for your credit score than a closed account.

Credit card debt is still the most important trade line on your credit report. This is called unsecured debt.  How you manage this debt is a better indicator of your credit worthiness. Therefore, unsecured debt has a significant impact on credit-scoring calculations.

Bottom line:  In most situations, it makes no sense to pay off your installment debt earlier than the agreed term. As long as you remain current on your loan, there’s no impact to your credit score by paying the minimum required by the contract. Credit cards, however, are a thorn in your side, financially speaking. Seize every opportunity to pay down your balance—including that tax refund, no matter how tempting it may be to spend it on a want, rather than a need.

The experts at Scorewell are experienced in helping individuals repair even the messiest credit scenarios. Connect with us for a complimentary consultation to discuss your situation and determine how we can help you achieve your best credit score possible. Email us today!

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