Tax season is coming!
Wait! Keep reading. Don’t close this post!
Yes, tax season makes just about everybody nervous. It can be a time consuming and complicated process. And sometimes it can be a financial burden. But we’re going to be optimistic today and make a positive assumption.
Let’s assume you’re going to get a tax refund. That’s not a huge stretch, because in 2014, 8 out of 10 Americans actually got a refund. And the average refund size was almost $2,800. Cha Ching!
When money suddenly falls into your lap, there is a temptation to blow it all. We’d suggest very strongly that you curb that urge.
Instead, we’d suggest, right now before you get your money, to look at where you are financially and figure out now what you should do.
The most important thing to do is look at your debt. List everything you owe from student debt, car loans, mortgages, credit card payments and payday loans. Go through the loan documents and find the interest rate or the APR (Annual Percentage Rate, which includes “points” or fees and charges added to your loan). Also be aware that sometimes there are fees that are not included in the APR, especially with payday lenders. Make sure you take that into consideration, especially if the fees are high or recurring. Click here for a great payday lender APR calculator.
Now rank your interest from highest to lowest. You will find that they generally go in this order: Payday loans, credit card debt, student debt, mortgages and car loans.
Now here is the fun part. Take all of your tax return money, and put it all to the highest APR debt you have. This definitely isn’t the most satisfying thing you could do with your money, but in one month, you will have more money in your pocket because your interest payments will have been reduced. And that is extra money every month that you can use to pay off more debt or to save for other things, or to invest!
When you get down the ladder to “good debt”, the debt with the lowest APR, there is more of a debate whether to pay it down or not. If you invest it, there is a chance that the investment will do better than the interest rate you’re paying (3.5% interest in your mortgage vs. a historic average 5% return on a stock). But the key here is “chance”. There is no guarantee on a more favorable return. And in this market, that is definitely not guaranteed. But having more money in your pocket next month after paying down debt IS guaranteed.
So keep all of this in mind when you look forward to your taxes this year. Of course we would love to see you invest some of your tax return – but only if your high interest debt is taken care of first.