Are you expecting a tax refund this year?
About 60% of Canadians are. It’s something to look forward to, and perhaps if you’re among that group you’ve already got plans.
According to a CIBC-sponsored Angus Reid survey, 21 per cent of Canadians use their income tax refund to pay off debt, while another 18% use it for day-to-day expenses like groceries.
For comparison’s sake, 35 per cent of Americans expecting a tax refund plan to use it in paying off debt.
Why would you want to use your tax refund to pay down debt rather than travel, renovate or party?
Because you’re smart.
Debt does more than cause you stress. The costly interest erodes what could be savings, and prevents you from doing things that add real quality to your life. In other words, debt drags you down, and in paying it, you redeem your freedom. That’s why financial advisors ALWAYS recommend getting rid of costly debt ahead of investing.
There are several different kinds of debt, so let’s look at each individually in the order in which you should pay them down.
1. Collection Agency Debt. If you owe collection agency debt, it’s undoubtedly causing you stress. And until you pay it off, your credit report and credit score will continue to be impacted. That means you won’t be able to get a mortgage, finance a car, or do other things that will make your life more fulfilling. So the most harmful and debilitating debt is that owed to a collection agency, to the extent that it can be worth using alternate borrowing mechanisms to clear it up if your tax return is not enough.
2. Payday Loans, Cash Advances and Installment Loans. These are often among the highest interest rate loans the law allows, usually close to Canada’s maximum annual interest rate of 60%. Pay down these loans as quickly as you can, and ahead of any others to avoid draining your income on interest levels designed only for short-term use.
3. Credit Card Debt. If you tend to make the minimum monthly payment on your credit card bills, you’re probably paying close to 20% interest. That amount of money in a positive interest environment could pay for your retirement or some nice vacations. Why hand it over to a big bank every month? If you can’t pay all your credit card debt with your tax refund, consider a debt consolidation loan at a lower interest rate, and cut up your credit cards to avoid a recurrence of the same problem. Spending habits are just that: habitual. You need to make lifestyle changes to avoid falling back into the bad ones and to create new ones that will reward you.
4. Auto Loans and Mortgages. Paying down a loan or mortgage ahead of time can save you thousands in interest charges. Most mortgages allow you to make a lum-sum payment without penalty at least once per year. Check your agreement or request one from the lender to find out exactly what is allowed. If you have multiple loans, find out which has the highest interest rate and pay it down first.
Set yourself free by paying down your debt! Unexpected windfalls like a tax refund or an inheritance are a really good opportunity to make progress and to rethink the way you manage money. It’s never too late to create good habits, but the sooner you start, the better off you’ll be!