Dear Dollar
Stretcher,
I have 4
children and do not work outside the home. As tax season
approaches we are anxious to get that large tax check. As usual,
we have it spent before it gets here. There are so many things we
need. My washer and dryer are breathing their last, the car has a
leak in the radiator. Then there is the desire for a date with my
husband. We haven't had any private fun in such a long time.
I know that
it would please our creditors to just plunk down the tax check in
their lap. There won't be enough to pay all of them. But when that
money is gone, what do we do to buy the high-dollar items that we
need? Would it really help to use maybe $1,000 or so of the tax
check on one of the loans? Should we use it on the highest
interest loan?
Cathy
Cathy asks a
good question. While it's tempting to use a tax refund to treat
yourself to some special purchase, in many cases it's more
important to use the money to pay off bills or make necessary
purchases.
The honest
answer to Cathy's question is - it depends. What she does with the
tax refund may be less important than what she does with the other
bills and expenses that she faces.
Using a
$1,000 tax refund to pay off her credit card could save Cathy $180
a year (assuming 18% interest rate). So if she's able to keep the
balance down she'd save that much every year for the rest of her
life.
However, a
more likely scenario is that she'll use the card for an auto
repair or other purchase soon after and have the same credit card
balance that she started with. In that case, she really hasn't
accomplished anything.
She can gain
an advantage by using the refund to pay down the account that's
charging her the highest rate of interest. Then put new purchases
on the card that's charging her the lowest rate of interest.
Cathy should
always be trying to move her debts to the lowest cost credit card.
It may not seem like much, but if she has a $7,000 balance and can
reduce her rate from 18% to 13% she'll save $350 each year.
What happens
if Cathy spends the refund? Again, it depends on what she buys and
how she buys it.
Anyone who
is married with children can appreciate Cathy's desire for a date
with her spouse. But, she might be better off planning a
candlelight dessert with hubby at home after the kids' bedtime
once each month.
What about
the auto repairs or a new washer and dryer? She could visit her
mechanic and have him install a new radiator. An alternative would
be to have her husband or a neighbor install a radiator purchased
at a junkyard. That could reduce the cost of the repair by 50% or
more.
It's
possible that the
IRS
refund could give Cathy some buying leverage. Take her washer and
dryer for instance. If she waits until they break she'll probably
be forced to buy immediately. Having the refund check available
means that she's a 'cash' buyer. That could allow her to drive a
better bargain. It would also allow her to look for a good used
deal in the paper.
Another
possibility would be to save the old washer and dryer. Perhaps a
$100 service call would buy some time.
The trick is
not to use the refund to momentarily feel wealthy and pay retail.
Use it to give you flexibility to make it go further.
There's
still one other option for her tax refund. She could use the money
for a cash emergency fund. In most cases it would be silly to keep
an emergency fund that earns money market rates (about 2%) while
she's still paying credit card debts at 18%. But, if Cathy could
learn to face emergencies without using her charge cards, it could
be worth it. Generally, once a family begins to put big expenses
on their credit card they'll always carry a balance.
Two final
thoughts. Part of every monthly budget should be money set aside
for medical, home and auto bills. It might not be easy setting
aside $50 or more each month. But it's essential. In Cathy's case,
she might want to find a part-time job that could generate that
much.
Cathy and
her husband may also want to have his withholding changed.
Remember that the IRS doesn't pay you interest on your withheld
taxes. So instead of getting a big refund each year, Cathy could
use the extra take home pay and use it to reduce those 18% card
balances each month.
Gary Foreman is a former Certified Financial Planner who currently
edits The Dollar Stretcher.
Email Gary:
