Do you know how a tax refund can boost your credit score
Filed under: Credit, Credit Repair
During tax season, conversations about how to use that always-anticipated tax return pop up all over the internet. Many who get a refund use it on vacations and other big ticket items. And while this isn’t always a bad idea, it may not be the wisest choice you can make for your tax refund.
One option is to use your refund with an eye toward increasing your credit score. A good score can save thousands of dollars in interest on a new mortgage or enable a homeowner to refinance to a lower rate. A high FICO score also helps consumers qualify for cash back, travel, and other rewards credit cards. It can even lower your car insurance premiums.
Whatever your financial goals, here are some tips on using your tax refund to increase your credit score:
1. Catch up on late payments
Your payment history is the single most significant factor in determine your score. Payment history accounts for 35% of your FICO score, according to the good folks at FICO. This means that a single late payment can have a disproportionately large effect on your credit score. It also means that the best way to maintain good credit is to make your payments on time, every month.
If you’re behind on any of your debt payments, use a portion of your tax refund to catch up as soon as possible. While it will take time for that late payment to fall off of your credit record, the sooner you catch back up, the more quickly you can boost your score.
2. Pay down maxed out credit cards
The next most important piece of your credit score is the amount you owe. This makes up about 30% of your overall FICO score. This section looks primarily at your debt-to-credit ratio, or how big a balance you’re carrying compared with your overall credit limits on credit cards and other revolving loans.
So your next most efficient tax refund move is to pay down credit card and revolving loan debt. The starting point is tackle cards that are maxed out. The credit scoring formula views a maxed out card as a sign a consumer is at the end of their rope. Paying this debt down can have a positive effect on a consumer’s FICO score.
3. Pay down other revolving debt
If you aren’t maxed out on a card, or if you’ve dealt with it already, consider paying down the rest of your revolving debt. This may include not only credit cards, but also lines of credit such as a HELOC. As a general rule, the lower your credit utilization the better. While FICO doesn’t publish explicitly guidelines on what makes the ideal credit utilization, Tom Quinn of FICO has suggested that 10% or less is ideal.
You may be surprised at how quickly paying down revolving debt can boost your credit score. And this strategy comes with another advantage: lower payments. Since your revolving debts likely carry the highest interest rates, paying them off can really reduce your monthly outflow. This makes it easier to continue making all your payments on time, so that your credit score continues to improve.
4. Save for emergencies
Saving for emergencies won’t by itself improve a credit score. The FICO score is not based on a consumer’s assets. In theory even a millionaire could have poor credit if he doesn’t pay his debts on time.
An emergency fund, however, will help you deal with the unexpected. Rather than charging a car repair, for example, those with money in the bank can have their car repaired without incurring more credit card debt. This in turn will help a credit score by keeping the credit utilization down.
The accepted rule of thumb is to save an emergency fund equal to three to six months of expenses. A high yield savings account is an ideal place to keep your rainy day fund, as is a CD ladder. Whatever approach you take, saving for emergencies can improve your score and offer peace of mind.
Getting started on building great credit isn’t rocket science. It’s all about managing your money well, making payments on time, and carrying low balances. If you can use your tax refund to jump-start some of those processes, you’ll come out ahead in the long term.
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