Using your tax refund (or stimulus checks) to make extra payments towards your debt program balance is an excellent way to reduce your debt burden.
If your credit card has an annual percentage rate (APR) of 25%, paying off $2,000 in debt now will save you roughly $500 in interest over the next year.
Lower credit card balances mean lower monthly payments. Paying off a card balance entirely translates into one less bill to pay, month after month. Once your debt account is paid down, you’ll have monthly funds to put towards other priorities (or wish list items).
Reducing your credit card balance will help to boost your credit score because it will free up some of the available credit that is granted to you by your creditor. If your total credit card limits add up to $10,000 and you have a current balance of $9,000, you are utilizing 90% of your available credit. If you contribute $1,000 toward your debt program, your credit utilization improves by 10%.
A common downside to using tax refund (or stimulus money) to pay off debt is that you can’t use it for your other priorities. There are many other events that come up in daily life which require a good chunk of change to afford, so it’s important to take your current situation into account.
However, keep in mind that you once you pay down your debt balance, you can always use the credit you’ve freed up to pay for the priority purchase (medical, home repair, childcare, car repair etc.) Most creditors offer great benefits for making purchases with their credit card, like purchase protections and rewards.
Why a debt program contribution could be better than paying off an installment loan.
Generally speaking, paying off debt helps your credit. At the most basic level, it marks the successful repayment of your debt—one of the very things your credit score is meant to track. However, if your tax refund was big enough that you could pay off the rest of your car loan, personal loan or mortgage, it wouldn’t necessarily improve your credit score. While successfully paying off an installment loan is a good thing, doing so means your loan account will drop off of your credit report. This reduces the diversity of your credit mix and/or lowers the average age of your accounts, which in some cases could reduce your credit score. This doesn't make paying off your loan a bad idea—after all, that's the idea of a loan. But if you're looking for a way to boost your credit score quickly, this may not be the way.
In summary, using your tax refund to pay down your debt program is an excellent option. Imagine the satisfaction you’ll get from being a little bit closer to your debt free goal!
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