Monday, June 13, 2022
HomeFinanceHow To Use Your Tax Refund To Build Your Credit

How To Use Your Tax Refund To Build Your Credit


By February, most of us have forgotten our New Year’s resolution to save more or build credit. But tax refund time represents one of the best opportunities to make good on those financial resolutions. 

If you’ve struggled to build credit in the past, you may be able to use your tax refund to build better credit. But you can’t simply buy a better credit score. Instead, you need to deploy your money strategically to ensure that you’re boosting your score as much as possible.

We’re partnering with Self to help you understand how you can put your tax refund to work to build your credit. Check out Self here and see how you can get started right now >>

The Components Of A Credit Score

Before you can put your tax refund to work, you need to know how credit building works. The credit system may seem confusing. But knowing the basics can help you find the best use of your funds.

  • Payment History: Payment history measures your record of making on-time payments for your debts. It accounts for 35% of your overall credit score.
  • Utilization Ratio: The utilization ratio is the amount of money you owe relative to the amount of credit available to you. Credit utilization accounts for 30% of your overall credit score.
  • Length Of Credit History: Length of credit history is the average age of your credit accounts, and it accounts for your most recent credit account opening. People with longer credit history tend to have higher credit scores. Length of credit history accounts for 15% of your credit score.
  • Credit Mix: Credit mix is the number and type of loans you have. Lenders often want to see your behavior with installment loans (like student loans, auto loans, and personal loans) and your behavior with revolving credit (like credit cards). Credit mix accounts for 10% of your credit score.
  • New Credit Inquiries: Credit inquiries indicate that you’ve asked a lender for a new form of credit. Typically, the credit scoring companies group loan inquiries for a mortgage or an auto loan together. They understand that people may want to shop around for the best rates. But a lot of recent credit inquiries for personal loans or credit cards are a red flag for lenders. They worry that you may be desperate for cash. New credit inquiries account for 10% of your credit score.
Credit Score Range

How A Tax Refund Can Help You Build Credit

A tax refund could be a windfall, and it won’t be directly reported to the three major credit bureaus. However, refund receivers can put their new funds to work to build their credit. Here are four ways you could use your refund to help you build credit.

Pay Down Maxed-Out Credit Cards

Credit utilization accounts for 30% of your credit score. When you have maxed out credit lines, your credit score takes a hit, and lenders are less likely to extend credit to you.

Paying down debt is one of the fastest ways to improve your credit score. When you reduce your credit utilization, credit scoring models typically interpret this as a positive.

 If your credit card has a limit of $500, you’ll want to owe less than $150 on the credit card at any given time. When you use your tax refund to pay down your credit card debt, your credit utilization will fall, and your score may see a boost.It is commonly recommended that you will want to aim for a credit utilization ratio of less than 30%.

Using a tax refund to pay off your highest interest loan can also feel like a huge victory in your journey to become debt-free. Typically, when you pay off an entire card, your minimum payments are now $0, so you can direct more money to your least favorite debt.

Keep It As An Emergency Fund

Putting your tax refund into a savings account won’t immediately build your credit. But holding cash on hand can keep you from borrowing on credit cards or using payday loans if you face an emergency.

The average tax refund for the 2020 filing season was $2,535. If you receive a similarly sized refund this year, you could have more than enough to cover a car repair, an unexpected parking ticket, or repairs for a broken appliance.

Holding money in cash can help when life doesn’t work out as expected. Cash on hand means you might not have to decide between making your loan payments or handling the emergency. By continuing to make payments against your debt, you’ll not only reduce your credit utilization, but you’ll also improve your payment history since your payments can stay on track during an emergency.

Related:
How Much Should You Have In An Emergency Fund

Use It To Open A Credit Building Loan

People with no credit may need somewhere to start building credit. Folks in this camp may want to use their tax refund to take out a credit building loan.

A credit building loan is a personal loan designed to help the borrower build credit over time. First, the full loan amount is put into a bank-held Certificate of Deposit (CD)where the borrower cannot directly access it. Then, the borrower makes payments for a set time, often 12 to 24 months. Over that span, payment history gets reported to three major credit bureaus. At the end of the loan term, the borrower receives the money from that initial CD, less any interest and fees owed. 

Companies like Self offer these credit building loans. Aspiring credit builders can choose between monthly payments of $25 to $150 for their credit building loans*.

People who have historically struggled with building savings and credit may use their tax refund to  open a credit building loan. Borrowers can deposit their refund check into a brand new bank account separate from their main checking account. Then, they can set up auto-payments from their new bank account to their credit building loan. By automating the payments, borrowers ensure that the payment is made on a specific date, potentially avoiding late payments and other pitfalls.

Check our Self Credit Builder Account here and get started >>

Open A Secured Credit Card

Secured credit cards are credit cards that require customers to make a deposit that secures the line of credit. For example, a person might put down a $300 deposit to create a $300 line of credit. Then that person can use the credit card and pay it off regularly. This creates a track record of payment history that may increase a person’s credit score when payments are made on time.

Lenders may want to see a trend of positive credit building behaviors before extending larger loans like a home mortgage or a low-interest auto loan. Using your tax refund to secure a credit card gives you the chance to start demonstrating this behavior.

Several credit card companies offer secured credit cards, but many of these cards are laden with high fees and impossibly confusing terms and conditions. Self allows its borrowers to open a secured credit card using the savings progress in their credit building loan account as security.  If you want to open the Self Visa® Credit Card, you must have an open Credit Builder Account in good standing, make 3 on time payments, and at least $100 in savings. Then you can apply for the secured credit card.**

Having both a personal loan and a credit card improves your credit mix, which may boost your score. It may also help you build credit provided that you make timely payments for both accounts each month.

Use your tax refund to setup a secured credit card with Self here >>

Avoid These Tax Refund Pitfalls If You’re Trying To Build Credit

You can potentially put your tax refund to work to help you build your credit. But there are pitfalls that credit builders should avoid at tax time.

Refund Advance Loans

Depending on the tax firm or lender, refund advance loans may not be reported to the three major credit bureaus – you would need to check with the individual lenders. While you’ll pay interest and fees, if the refund advance loan isn’t reported, you won’t see a boost to your credit score from taking out one of these loans.

Putting A Down Payment On A Vehicle You Can’t Afford

A tax refund can be a bonus, and many people want to use the funds to put a down payment on a car. In some cases, this is a good use of the extra cash.

Unfortunately, people with a limited or poor credit history are unlikely to find a reasonable rate on an auto loan. Rates on auto loans can climb as high as 36%. If your auto loan has rates in the double digits, you may struggle to afford the loan payments. “Buy Here, Pay Here” car dealerships often take advantage of people around tax refund time. They require massive down payments. Then they issue loans that many people will struggle to repay.

Borrowers who miss payments on their auto loans are more likely to have their car repossessed. In the process, the missed payments may destroy their credit. If at all possible, try to build your credit before you need an auto loan. This will help you qualify for a loan at a lower interest rate.

Paying For Improved Credit

“Credit Repair” companies often advertise that they can improve your credit score for a fee. Typically, these programs dispute negative credit events on your credit report. This is something you can do on your own if your report contains mistakes. But if your report is accurate, disputing information won’t build your credit.

While the companies may not succeed in helping you build credit, they might succeed in taking several hundred dollars away from you. Avoid these scams. The only way to build credit is to demonstrate positive credit behavior.

Final Thoughts

You only get your tax refund once a year. Instead of spending it on something that you may lose interest in a few weeks later, this year, use it to build your credit – which can help you get on a path of better financial results across the board.

Remember, a higher credit score may help you:

  • Not have to pay security deposits for utilities like cell phones or power
  • Get lower insurance premiums
  • Be able to rent that apartment you’ve been waiting for
  • Get lower interest rates on car loans and mortgages

Basically – improving your credit score could save you a LOT of money! And using your tax refund with tools like Self’s Credit Builder Account and then setting up a secured card could go a long way to making it happen.

Check out Self here and get started >>

DISCLOSURES

All Credit Builder Accounts made by Lead Bank, Member FDIC, Equal Housing Lender, Sunrise Banks, N.A. Member FDIC, Equal Housing Lender or SouthState Bank, N.A. Member FDIC, Equal Housing Lender. Subject to ID Verification. Individual borrowers must be a U.S. Citizen or permanent resident and at least 18 years old. Valid bank account and Social Security Number are required. All loans are subject to ID verification and consumer report review and approval. Results are not guaranteed. Improvement in your credit score is dependent on your specific situation and financial behavior. Failure to make monthly minimum payments by the payment due date each month may result in delinquent payment reporting to credit bureaus which may negatively impact your credit score. This product will not remove negative credit history from your credit report. All loans subject to approval. All Certificates of Deposit (CD) are deposited in Lead Bank, Member FDIC, Sunrise Banks, N.A., Member FDIC or SouthState Bank, N.A., Member FDIC.

* Sample products: A loan with a $25 monthly payment, 24 month term with a $9 admin fee at a 15.92% Annual Percentage Rate with a finance charge of $89; A loan with a $35 monthly payment, 24 month term with a $9 admin fee at a 15.97% Annual Percentage Rate with a finance charge of $125; A loan with a $48 monthly payment, 12 month term with a $9 admin fee at a 15.65% Annual Percentage Rate with a finance charge of $46; A loan with a $150 monthly payment, 12 month term with a $9 admin fee at a 15.91% Annual Percentage Rate with a finance charge of $146. Please refer to www.Self.inc/pricing for the most recent pricing options.

** All requirements are subject to change.

RELATED ARTICLES

LEAVE A REPLY

Please enter your comment!
Please enter your name here

- Advertisment -
Google search engine

Most Popular

Recent Comments