It’s no secret that having a great credit score is beneficial. It makes being approved for loans easier, gets you a lower interest rate, and means you pay less interest overall. But, the benefits of good credit go far beyond just loans. For example, some employers will check your credit score before hiring you. Also, landlords will often review your credit before you can move in. Some utility companies even waive the required deposit if your score is high enough. While it may not make sense at first, tax refund season is the perfect opportunity to give your score a boost.
To understand how, let’s review the different parts of your credit score.
Components of a Credit Score
- Amount Owed: How much you currently owe on your outstanding loans and credit cards.
- Payment History: How well you manage your financial obligations, including missed or late payments.
- Types of Credit: What your credit mix looks like, such as secured loans (auto or home) and unsecured loans (credit cards or personal loans).
- New Credit: Lines of credit or loans that you recently applied for or received.
- Length of Credit: How long your credit history is and the average age of your current credit accounts.
How to Boost Your Credit Score During Tax Time
After going through the hassle of filing your taxes, using your tax refund check for a nice vacation might be ideal. However, using your tax refund to improve your credit score could help you save even more money down the road.
The two most influential and important components of your credit score are “Amount Owed” and “Payment History.” Luckily, your tax refund can help improve both areas.
1. Your Tax Refund Can Reduce Amount Owed
Using a portion of your tax refund to pay off existing debt is a wise move.
- First, it helps you reduce the amount of interest you’re paying each month.
- Secondly, it will give your credit score a boost.
When paying down debt, focus on unsecured debt first. This includes any loan not backed by collateral, such as credit cards or personal loans. Since these loans are unsecured, they typically have the highest interest rates.
2. Your Tax Refund Can Help You Maintain Good Payment History
Another strategy to boost your credit score with your tax refund requires a more proactive approach. Since payment history plays a significant role in your credit score, you can use your tax refund to ensure you never miss a payment in the future.
Deposit a portion of your tax refund into your emergency fund. Then, if you lack the funds to make a loan payment one month, you can dip into your savings to cover the amount and avoid any negative marks on your credit report.
Building your emergency fund is a proactive measure that protects your credit score down the road. Ideally, you should aim to put three to six months of living expenses in your emergency fund.
3. Your Tax Refund Can Improve Two Key Ratios
By paying off credit card debt with your tax refund, you actually improve more than just your credit score. In addition to your credit history, lenders also use two popular ratios when deciding if they will approve a loan. Unsecured debt ratio and credit utilization ratio.
Unsecured Debt Ratio: Lenders assume more risk when lending money that isn’t backed by collateral. That means credit cards. This ratio allows them to gauge how much risk they are taking by lending you money.
To calculate your Unsecured Debt Ratio, divide your total unsecured debt by your annual income x 100. Most lenders prefer this number to be under 25%.
Credit Utilization Ratio: Lenders like to see that you can manage credit responsibly. One way they do this is by calculating how much of your available credit you’re using.
Both of these ratios will improve as you pay down your credit card balances. For example, if your credit card limit is $10,000 and your current balance is $7,500, you would be using 75% of your available credit ($7,500 / $10,000 x 100). Lenders prefer this number to be below 30%.
You’ll save money on interest and boost your credit score by using your tax refund to pay off high-interest, unsecured debt. Plus, you will improve the two key ratios lenders use when approving loans.
We’re Here to Help!
Using your tax refund to boost your credit score might not be as exhilarating as taking a mini vacation, but the long-term benefits could be significant. You could make a significant difference in your financial life even if you tried it for two years in a row.
Your credit score is one of the most important numbers in your adult life. Your tax refund offers you the opportunity to improve that figure without too much sacrifice on your part.
Want to monitor your credit, see your score, and get your full report each month? Enroll in My Credit from our mobile app or online banking today. Just look for “My Credit Score and Report” in your app’s flyout menu or on the Accounts page of online banking.
For more information on improving your credit score or setting up an emergency fund for those unexpected expenses, we’re ready to help. Call, text, chat, or stop in. We’re here to help M-F, 9am-4pm ET.
Each individual’s financial situation is unique and readers are encouraged to contact the Credit Union when seeking financial advice on the products and services discussed. This article is for educational purposes only; the authors assume no legal responsibility for the completeness or accuracy of the contents.
