As a freelancer, I usually expect to pay hundreds of dollars, if not thousands, in taxes each year. That’s why I was shocked to find out I was actually getting a refund this year.
Not only was I getting some of my hard-earned money back, but it was a substantial amount at that. As I sat there, staring at the number, visions of shopping trips danced in my head: a vacation to Italy, a down payment on a new car, a washer and dryer… the options for what I could do with that kind of money seemed endless.
Then reality hit me.
Like many of my peers, I have student loan debt. In fact, 40 million Americans have at least one student loan. No doubt, a sizable tax refund could help put a dent in that debt.
Using a tax refund to pay off student loans
According to our recent survey on student loans and taxes, nearly 40 percent of taxpayers receiving a refund this year plan to use the money to pay down debt. Though it might not be as fun as splurging on something I want, I plan to be one of them.
Using a cash windfall is one of the best ways to pay down student loans faster. Making an extra payment with a large chunk of change can cut months – even years – off the time you spend repaying your loans and reduce the total amount of interest you pay, too.
However, you can make your tax refund go further by being strategic about your money. Here’s what we recommend.
How to kill your student debt with a tax refund
1. Check the emergency fund first
Picture this: you proudly apply that big tax refund check to your student loan. But suddenly, you lose your job, have a medical emergency, or need an expensive car repair. How will you make your future loan payments in such a crisis?
That’s where an emergency fund comes in, and it’s an important part of your debt repayment plan. Without a safety net of savings to cover your basic necessities and expenses, your finances could be in a ton of trouble if disaster strikes and that tax refund is already gone and spent.
Before you cash in that tax refund towards your student loans, consider building an emergency fund of at least $1,000 first for that extra peace of mind. You never know what tomorrow may bring – having money in the bank allows to focus on student loan repayment even when things go wrong.
2. Pick your student loan payoff strategy
When it comes to making extra student loan payments, it’s important to have a specific strategy in mind so you can pay off your debt quickly while also saving as much money as possible.
There are two major debt repayment strategies out there – the debt avalanche and debt snowball.
With the avalanche method, you focus on putting as much money as possible towards the loan with the highest interest rate first, while paying the minimum on all the rest. This strategy saves more money the long run by cutting down the total interest you pay.
However, if you are in need of more motivation to stick with an aggressive payoff strategy, the snowball method may be a better option. With this method, you focus your extra dollars on the loan with the smallest balance instead and work your way up, allowing you to achieve wins immediately and find the motivation to keep going.
3. Get your loan servicer on the same page
If you’ve ever tried to make a larger student loan payment than your usual monthly amount, you might have noticed those extra funds didn’t make much of a dent.
That’s because lenders will distribute your payment towards any outstanding fees first, then interest, and then finally, the principal. Plus, in most cases, any extra money over your required monthly payment will be divided up evenly among all your loans.
For example, imagine you have two loans with the same lender – one for $2,000 at 7.50% and one for $5,000 at 4.00%. You plan to pay down the $2,000 loan in full with a single payment because the interest is so much higher.
But your servicer doesn’t know this, so the payment is automatically distributed evenly among your loans – $1,000 to each. You will still end up with two loans to pay off, including the one with higher interest.
However, you can avoid this and make sure your payment is applied the way you want by contacting your servicer. Let them know how you would like your payment distributed, including whether this is a one-time request or a change to all future payments.
The bottom line: put your tax refund to work
Your tax refund shouldn’t be treated simply as extra spending money. With student loan debt playing such a significant role in your life and finances, making it a priority to pay it off faster with that refund is the perfect way to reduce your burden. Make the most out of receiving a tax refund this year by being strategic and forward-thinking.