Using Tax Refunds to Tackle Debt: How These Borrowers Did It

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If you get a tax return this year, you’re probably tempted to spend that money on something fun. But if you owe money, it might be a smarter financial decision to use your tax return to pay off debt.

According to the IRS, the average tax refund as of July 24, 2020, was $2,874. This extra cash could help you take a big step closer to freedom from debt, especially if you combine it with the right debt payoff strategy.

Here’s the proof: five people who used their refunds to help pay down debt ranging from $600 to a whopping $360,000. Have a look at five ways they used that money…

1. Eliminating low-balance, high-interest debt
2. Paying down student loans on an entry-level income
3. Freeing up monthly cash flow
4. Negotiating with debt collectors
5. Controlling interest costs of income-driven repayment
PLUS: Using your tax return to pay off debt

1. Eliminate low-balance, high-interest debt

“The first job I had barely covered the rent and groceries,” said Lou Haverty, founder of Financial Analyst Insider. “So I gradually built up a small running balance on my credit card to pay the difference.”

The credit card seemed like a lifeline until Haverty realized the costs that came with it. He paid what he could afford on the debt each month but couldn’t keep up with the interest charges. His credit card balances were still creeping up.

So when Haverty got his tax refund from his first job after graduation, he used his tax return to pay off debt, specifically to wipe out his $600 credit card balance.

“I reduced the balance low enough so that I could finally start paying the balance in full each month,” Haverty said.

Since he no longer carried a balance, he avoided paying credit card interest and freed up funds to put toward other financial goals.

2. Pay down student loans on an entry-level income

Zina Kumok, a personal finance writer and founder of Conscious Coins, also struggled to scrape by on her entry-level income right out of college.

“I was only making between $28,000 and $31,000 a year while I had student loans, so I had to be really judicious with my money,” Kumok said.

While she was paying down her initial student loan balance of $24,000, she said “almost every spare dollar went toward my loans.”

That included Kumok’s tax refunds. While repaying her student loans, Kumok put 70% of her tax returns to pay off debt.

“I loved putting a huge chunk on the principal at one time,” she said. “It gave me such a thrill.”

With her efforts, Kumok was able to put $28,000 toward her loans (principal plus interest) to pay them off in just three years.

3. Free up monthly cash flow

Before getting serious about paying down debt, Allea Grummert, who formerly blogged about personal finance at AskAllea.com, said she “was in a tight place with cash flow.”

“All my money was tied up in car loans and student loan debt,” she said.

Grummert needed a change: She picked up a side hustle, followed a strict budget, and only used cash for purchases.

“With my laser-focused goal of debt repayment still fresh and in action, there were months when I was able to put upwards of $600 toward my student loans,” she said.

Her efforts paid off, and soon her $8,500 car loan was down to $3,000. After receiving a $1,000 tax refund, Grummert put $900 toward her car loan.

Thanks to her hard work and the lump-sum extra payment, Grummert paid off her car loan just two months later.

4. Negotiate with debt collectors

Raeshal Solomon, a speaker and author of children’s personal finance books, went from owing $400,000 in 2011 to owing $40,000 today. Every year, she used her tax refund to get her closer to her goal of being debt-free.

“When I started trying to get out of debt, I had little income,” Solomon said. “My tax return was a great weapon for me to get rid of some of my debt.”

In fact, Solomon strategically leveraged her tax refund in debt settlement negotiations.

“I always knew my total refund amount before I received it, so I used that information to negotiate with the debt collectors,” she said. “The collectors knew it was tax time too and if they didn’t take this amount they might never get their money.”

5. Control interest costs of income-driven repayment

An income-driven repayment (IDR) plan, which sets your monthly payment at a portion of your income, can be a huge help for borrowers with high student loan balances.

That’s why Josh Hastings, co-founder of personal finance blog Money Life Wax, enrolled in an IDR plan to manage the combined $300,000 student debt he and his wife had.

With lower monthly payments, the Hastingses used the debt avalanche method to put more money toward high-interest balances. So far, they’ve knocked out $110,000 in student debt in just two years.

Even so, interest was accruing.

“Since we use a debt-to-income repayment plan, this year we had $6,000 in accrued interest that was set to capitalize in March,” Hastings said.

If that $6,000 was added to their balance, they’d start getting charged interest on that too.

“Instead of letting the accrued interest become part of our principal balance, we decided to use our tax return to pay off the interest so we can keep our ‘debt snowball’ rolling,” Hastings said.

By using their tax return to pay off debt, he said they “went from paying $17,000 in interest in 2016 to just $6,000 in 2017.”

Final thoughts on using your tax return to pay off debt

“Know your goals” when using a tax refund to help pay off your debt, Grummert said. Being clear on what’s important to you will guide you to the debt payoff strategy that will help you achieve it.

And for next year, consider whether you might benefit from bigger paychecks rather than a tax refund.

“I should’ve recalculated my withholding so I’d have that money throughout the year,” Kumok admitted.

If you’re already getting a refund, however, make the most of it.

“Since I did have a refund, I’m just glad I didn’t blow it shopping or buying something silly,” Kumok said.

By prioritizing your loans, you could get out of debt ahead of schedule.

Rebecca Safier and Ben Luthi contributed to this article.