07 Apr How should I spend my tax refund?
Q. I have a $5,000 tax refund coming to me. I’m trying to decide how to use it. I have $2,000 in credit card debt and a $10,000 car loan. I also would love to go on a nice vacation. How do I decide what to do with the money?
A. Glad you’re thinking of your long-term goals rather than just going on a spending spree!
And while your desire to go on vacation is certainly understandable, it is important to keep your financial priorities in mind when deciding how to use “found” money.
Debt is the first thing to consider.
You should prioritize loans that are the most costly to carry, said Chadderdon O’Brien, a certified financial planner with Lassus Wherley in New Providence.
Without knowing the specifics, the credit card probably carries a higher interest rate than your auto loan, but the balance of the auto loan is five times larger than your credit card debt, he said.
“Knowing the actual interest expense you incur on each loan is a critical factor,” he said. “Whichever loan has the highest monthly or annual cost should be paid off first.”
The obvious next question relates to the remaining $3,000, O’Brien said. What should you do with the extra money?
“While it is reasonable to pay down the auto loan, it is also worth mentioning the need to maintain emergency reserves for unexpected expenses,” he said. “If you were to incur a costly car repair, or another unplanned expense, would you have the cash you’d need or would you need to use your credit card?”
If you’d need to use the credit card to meet an unexpected expense, he recommends you keep the extra $3,000 in a savings account for safety.
Over time, as you manage your expenses and savings you’ll begin to build up the balance in your savings account, he said. When you feel comfortable you have the reserves to meet unexpected expenses, you can reward yourself with the vacation you deserve.
Going forward, consider revamping your tax withholding so you no longer give an interest-free loan to the IRS.
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This story was first posted in April 2015.NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.