This is the time of year when many consumer taxpayers are receiving their income tax refunds. While some of that money may be earmarked for special purposes – such as a vacation, large retail purchase or home improvements – many times it will be used to pay debt for which the consumer was already obligated. With the recent news that consumer borrowing was at one of its highest levels for December, 2012, it is very likely that even more consumers will be holding off on purchases, and using their refund money to pay debts. Unfortunately, many consumers exhaust their tax refunds in a manner that offers short term relief, and find themselves in a budget crisis within a few months. This article will offer some suggestions as to how the income tax refund should be best spent for the consumer’s benefit.
First, pay any secured debts that are delinquent, such a house payment or car payment. While home and auto lenders may not be as aggressive in their collection calls as some other creditors, they have the ability to foreclose/repossess their collateral. Ideally a consumer would have the ability to catch up all delinquent debts, but if not, they need to concentrate on the lenders who can deprive them of their home or means of transportation. Secondly, pay any expenses that may be associated with the home or car, such as homeowner’s insurance, full-coverage auto insurance or property taxes. Failure to pay required taxes or insurance will usually cause you to default on home or auto loans, even if the monthly payments are up to date.
Once the secured creditors have been addressed, the consumer should concentrate on unsecured debts that would be considered “priority” or “non-dischargeable” in a bankruptcy. These debts would include child support, alimony, taxes and student loans. For some of these debts – such as child support – there can be significant consequences if they should get too far behind. Only after these debts are paid should the consumer begin making payments on other unsecured debts.
The next category of debt to be addressed would be unsecured debts for interest bearing loans, such as credit cards and personal loans. Be realistic about the way credit cards are to be paid. If the balance has become unmanageable, then discontinue use of the card prior to making any large payments. Otherwise, the balance will soon return to its payment level prior to the refund payment. With smaller personal loans – especially payday loans with high interest rates – you are better off paying the debt in full, rather than just catching up past due payments.
Finally, the last category of debts to be addressed would be the non-interest bearing unsecured debts, such as medical bills. While these debts may be aggressively collected – especially if turned over to a collection agency – they don’t accrue interest which means that the balance will not continue to increase over time as it would for a credit card or payday loan. As a result, a delay in repayment of the debt will not increase the amount of the debt. In addition, the option for settling the debt for lump-sum amount which would be less than the claimed balance may be available.
This is not an exhaustive list, and there will always be certain circumstances which would change the prioritization schedule such as the following: lawsuits, garnishments, judgments or cosigned obligations. Hopefully this will help consumers in maximizing the benefit of debt repayment, so that they are not struggling with the remaining debt just a few months after receiving their income tax refund.