Last Updated: March 3, 2024
4 min read
Key points:
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Using your income tax refund to pay off or pay down credit card debt can have longer-term financial benefits than simply reducing what you owe.
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It may benefit you the most to pay down the balance on a credit card with a high interest rate.
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Paying credit card debt can reduce your credit utilization rate, which may improve your credit score.
Many Americans receive a tax refund each year, providing a welcome windfall to millions of households each spring. In 2022, the Internal Revenue Service (IRS) reported more than 110 million individual income tax refunds were issued worth approximately $359 billion, with an average refund of $3,252.
Getting a tax refund often feels like “free money” or “extra money,” but in truth, your tax refund is your money that you overpaid to the government throughout the year. And getting a tax refund can be a benefit to your personal finances.
There are a lot of things you could do with your tax refund, and one option is paying off credit card debt, which can be beneficial to your finances in more ways than one.
You could pay down your high-interest debt
If you’re carrying a $10,000 balance on your credit cards and paying just the minimum monthly amount , over time, the interest payments may cause you to pay thousands of dollars more than you borrowed in the first place. That’s why if you use your tax refund money to pay down your credit card debt, you may be able to save money in the long run.
You could improve your credit utilization ratio
Your credit utilization rate is the percentage of your available credit that you are actually using. For example, if you have a $10,000 credit limit on your credit card, and you have $5,000 of credit card debt, your credit utilization rate is 50%.
In general, a lower credit utilization rate is better for your credit score. It shows that you are not using up every available dollar of credit that has been offered to you.
Along with making prompt, on-time payments each month, reducing your credit utilization rate could positively impact your credit, and a better credit score could help you save money later by qualifying for lower-interest credit cards. You may even be able to complete a balance transfer to consolidate your debt at a lower interest rate.
Did you know?
If you already carry a low balance on your credit card, and don’t need your tax refund to pay down credit card debt, you could also improve your credit utilization rate by adding a new credit card and increasing your available credit.
Your tax refund can be used strategically
If you can’t afford to pay off all of your credit card debt, using your tax refund as a one-time source of funds may help kick-start your efforts to pay down your debt and reduce your overall credit utilization.
For example, let’s say you receive a $3,000 tax refund. You have two credit cards: one with a balance of $5,000 on a $10,000 credit limit (50% credit utilization), and one with a balance of $1,000 on a $5,000 credit limit (20% utilization). You could use your $3,000 tax refund to reduce the $5,000 balance to $2,000, bringing that card’s utilization ratio down to 20%. Even though you didn’t pay anything toward the other card’s $1,000 balance, this move could still help improve your credit utilization rate.
It’s not every day that someone suddenly receives a couple “extra” thousand dollars in their bank account. Paying off your credit card debt —or even paying down the balances on your cards in a strategic way to improve your credit utilization—is one way you could use your tax refund to boost your financial stability.
