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Each year as you await your tax refund, you face the same question – what to do with that money once it arrives? For some, the money immediately goes to cover basic needs, but for others, the money goes to far less-essential items.
According to a 2020 survey by Self Financial, 44% of respondents said not getting a tax refund this year would completely derail their budget for the rest of the year.
So how do you use your tax refund to plan ahead, build your wealth, financial health, and ultimately, your credit?
Here are 5 ways to put your tax refund to work to build your credit.
Why use your tax refund for credit-building?
Maybe you’re itching to spend your tax refund to treat yourself. While there’s nothing wrong with using a bit of that money for fun, tax refunds are a great opportunity to get ahead with your finances too.
But why, of all things, focus on your credit?
First, bad credit could cost you thousands of dollars more over your lifetime, since you often get charged higher interest rates (if you can get approved at all). Your credit can also impact your ability to rent an apartment, qualify for certain jobs, or even get a cell phone.
Good credit, however, creates a financial safety net to fall back on if you need it. If you have good credit, you may have an easier time qualifying for personal loans, credit cards, or other credit products if you need to borrow money, often at a lower rate.
If you don’t have an emergency savings fund, credit may be your only other option to lean on if you face job loss, an unexpected medical emergency, etc.
You have to build credit before you need it though. Otherwise, you might not be able to access it when you actually do need it.
5 ways to build credit using your tax refund
Once you have your tax refund in hand, here are some ways you can put it to work to help your financial health.
1. Pay down debt
While paying down your mortgage or other personal loans may help your credit score, it may be a good idea to focus on higher-interest, more expensive consumer debt (like credit card debt) first.
Not only could paying down this higher-interest debt save you the most money in the long run, but it could also have a bigger impact on your credit score. That’s because credit usage, or how much of your available credit you use at any given time, counts for 30% of your FICO® credit score.
While installment loan usage (like personal loans, car loans, or home loans) does count somewhat towards this factor in your credit score, revolving account balances (like credit cards or HELOCs) count more, according to credit bureau expert Barry Paperno.
That doesn’t mean you have to pay your credit card debt off completely to see benefits to your credit score. Even paying your balance down 5-10% may have a positive impact.
According to credit scoring agency FICO, people with the highest credit scores tend to have credit utilization between 6-10% on their revolving credit accounts. While that’s a great goal to aim for, start with paying down what you can, no matter how small that amount may seem at first. Small wins can add up to big ones over time.
Aside from credit utilization, the only other factor that impacts your credit score more is your payment history. Which brings me to my next point…
2. Get your current accounts in good standing
If you have late payments or missed payments on your current credit accounts, make up those payments if you can. While many lenders report a late payment to the credit bureaus if it’s more than 15 days late, how late your payments are can impact your credit score in different ways. A payment that is 30 days late affects your score differently than one that is 90 days late.
For example, according to one FICO score simulation, if you have a 793 credit score and miss a payment by 30 days, your score could drop 60-80 points. In that same situation, if you missed a payment by 90 days, your score could drop 100 points or more.
So the sooner you catch up on a late payment, the better. Besides, making those payments could keep more late fees from adding up.
While catching up on payments may not undo the damage of a late or missed payment on your credit (it can take years for just one late payment to fall off your credit report), it could prevent any more damage from being done.
If the late payments were on property, or loans that were secured by property, like a home loan or car loan, catching up on payments could also prevent you from losing your home or car.
3. Open a Credit Builder Account
This next one is for people who either have no credit history, a limited credit history, or need to rebuild credit after financial hardship such as bankruptcy, foreclosure, or identity theft, to name a few examples.
Unlike a traditional personal loan, credit builder loans don’t give you the money upfront.
Instead, the lender holds the loan amount in a bank account. Each month, you pay into this account and the lender reports your payment history to the credit bureaus, which helps you build credit history.
Once you pay off the loan amount, the money inside the account comes back to you, minus the interest charged on the loan. In other words, these loans give you the opportunity to put some money away for savings while you build your credit.
If you have trouble gaining access to other credit products or want to build credit while you build some savings, a Credit Builder Account could be the right option for you.
4. Use it as a deposit on a secured card
For many, a secured credit card may be a good entry point for accessing credit cards. A secured card works just like a regular credit card, except you put down a security deposit that is usually equal to your credit limit.
For example, you may have a secured card with a $100 credit limit and a $100 security deposit. Like a deposit for utilities, a secured card deposit is used to cover your bill if you don’t pay back what you owe.
Some companies (like Self Financial) provide an option for you to build your way slowly towards a secured card through a Credit Builder Account, no extra deposit or hard inquiry needed. Bonus: Self doesn’t deny you if you have a history of bankruptcy or foreclosure, unlike some other credit card issuers.
There are many different secured credit cards to choose from, so shop around to decide which one is right for you.
5. Work with a credit counselor
Not sure where to start when it comes to your credit? Or what product might work best for you? You may want to use some of your tax refund to hire a qualified professional to help you come up with a credit action plan.
Here are a few reputable places to start searching for a credit or financial counselor:
- National Foundation for Credit Counseling (NFCC). This nonprofit provides financial counseling services through their member organizations across the US. Visit their website to connect with free or low-cost help in your area.
- Association for Financial Counseling and Planning Education (AFCPE). AFCPE has over 3,200 certified financial counselors, planners, educators, and researchers around the world. You can find local or virtual financial counseling through their online tool.
- Operation Hope. Operation Hope is a national nonprofit that provides financial coaches to help people “develop customized action plans around building their own businesses, raising their credit scores, buying homes, or simply making better decisions with the money they have.” Their website also has tons of free resources about financial basics.
These organizations provide access to qualified financial counselors who can help you create plans that align with your financial goals, whether that means building your credit, paying down debt, budgeting, or working towards buying a house, to name a few examples.
Depending on your current income and situation, you may also qualify for no-cost or low-cost help, since many financial counselors offer a sliding scale based on financial need.
Be careful when browsing for professional help with your credit though, especially if you search for credit repair. While there are some good players in the space, you have to be really careful to pick the right one. The Federal Trade Commission provides some guidelines to help you find legitimate credit repair help, which you can view here.
Bonus: Build an emergency savings
Okay, so this one isn’t exactly credit-specific, but having an emergency savings fund could help reduce the amount you need to borrow if you ever did need to lean on credit during times of financial hardship.
Research from SaverLife shows that even just $100-$200 in savings could mean the difference between keeping your housing during hard times or having your utilities cut off.
According to the IRS, the average tax refund in 2020 was $2,741, which for people who make about $30,000 is roughly one month’s salary – a pretty healthy cushion if you lose your job and need time to find something new.
The good news is, there are tools that could help you build both your credit and some savings at the same time.
While credit may not usually be top-of-mind when you get a sudden rush of cash, it’s a key building block for your financial health, and can help open doors to your future.
So if you have a little extra money, whether it’s thanks to a tax refund, stimulus check, bonus, raise, inheritance, or even just finding $20 in an old pair of pants, put that money to work for your future self.
The post How to Put That Tax Refund to Work to Build Credit appeared first on MintLife Blog.