How to Use Your Tax Refund to Build Credit

Do you look forward to tax time? For some, it’s exciting because you know you’ll get a refund. It’s found money, like that $20 bill you find in the pocket of a coat you haven’t worn in a long time. But what to do with found money? Usually our thoughts go to all the cool ways we could spend the money; but I suggest using it to help further your financial goals. Yes, I love impulse buys now and then, too, but I’m your credit coach — of course I’m going to suggest using your tax refund to further your goals of improving your credit. So step away from the checkout counter for a minute and consider these options.

1. Focus

Any time you make or find extra money, it’s best to use it where it’s going to benefit you the most. Use your tax refund to target one of your healthy credit goals such as paying down your credit cards to 35% or less of your limits (less than 10% is best). Using a low percentage of your available credit can benefit your credit score. If you want to track your credit-building progress, there are many ways to get your credit scores for free, including through Credit.com, where your scores are updated every 14 days.

2. Clean Up Old Messes

Another great way to use your tax refund is to consider wiping out old, bad debts. When you use found money to pay down debt, rather than spend it, it pays you back double. If it’s an old debt that has gone to collections, there are several factors to consider before you proceed, especially if you don’t have the amount to pay it in full. However, if it’s a debt you’re paying down and current on, and you just want to pay it off, you’ll then have the benefit of being that much less in debt.

Keeping up to date on your debts can lead to a healthier credit report over time, which translates into lower interest rates you’ll pay on big-ticket purchases — like a home or a car — that likely matter much more to you and your family than that impulse buy. (You can see how your credit affects your lifetime cost of debt using this calculator.)

3. Make Sure It Doesn’t Happen Next Year

When I hear my clients tell me they get huge tax refunds, I cringe because basically what they have done is loan money to the government for 0% interest while they struggle to pay their bills, and pay 18% interest on their credit card balances. It’s not a good strategy. So if you are used to getting a large refund, I’d recommend speaking to a tax professional to see what you can do to bring more money home throughout the year when you actually need it.

Found money, whether through a tax refund or a coat pocket, can be so thrilling. But remember to keep calm and set your focus on achieving your healthy credit goals … so you can make the decisions that will help you reach those goals sooner.