Latest data from the IRS shows that American taxpayers thus far are seeing an average refund amount of $3,125. While you may feel inclined to spend what feels like "free money" (it's actually money you overpaid the government in 2019) splurging on a vacation or a luxury purchase for its instant gratification, you'll profit more in the long run if you use it wisely.
Paying your credit card off, or just paying down its balance, with your tax return can help you improve your credit utilization, boost your credit score and become overall more financially stable in 2020.
With already over 37 million people receiving a tax refund this year, CNBC Select spoke to personal finance, credit and tax experts about how using this windfall of cash to pay off your credit card(s) will help you accelerate your path toward achieving debt freedom.
In general, using your tax refund to pay down debt, especially higher interest credit card debt, makes sense from a long-term perspective as it will help save you from incurring future interest charges.
"Personal interest, including credit card interest, is not tax deductible," Steven Rossman, CPA and shareholder at Philadelphia-based accounting firm focusing on taxation Drucker & Scaccetti, tells CNBC Select. "Using your tax refund to pay the highest interest credit cards would be the most beneficial, as you would save on interest that is not tax deductible."
It makes sense to use the "extra money" you receive to pay down your unpaid credit card debt, focusing first on the highest interest balances. That is, unless you have past due accounts that are incurring late fees on top of the interest, in which case you should ensure that those balances are tended to.
"It's probably costing the person 12% to 18% in non-deductible interest," Andy Byron, a certified financial planner and principal with HC Financial Advisors, tells CNBC Select. Putting extra cash towards high-interest debt is "like investing and getting a 12% to 18% return."
In other words, says Byron, — "it's a no brainer."
It isn't necessary to use your refund to pay off your credit card accounts when you are taking advantage of a 0% APR period. But it probably makes financial sense if your promotional financing period is almost up.
"The exception would be if the interest-free period is about to expire and there is a chance that the balance would begin accruing interest unless the tax refund is used to pay it off," Bruce McClary, a spokesman for the National Foundation for Credit Counseling (NFCC), tells CNBC Select.
An influx of cash in the form of a tax refund may be just enough to pay off an existing balance and free up your money for something more meaningful.
"By using a lump sum tax refund to pay debt, you minimize the total amount of interest you would otherwise pay over the life of the loan," Bola Sokunbi, a certified financial education instructor and author of "Clever Girl Finance," tells CNBC Select. "And that savings each month can be put towards other goals.
"Some other goals to pursue could include catching up on your retirement savings, saving for a home down payment, starting a small business, taking a class, etc.," Sokunbi says.
Each of these goals, in some way, can improve your financial circumstances down the road, but they are not possible if debt is in the way.
Reducing your debt load will have a major impact on your credit score.
"When the amount you owe is at or near the credit limit, your credit utilization rate is out of balance," Erica Sandberg, consumer finance expert and author of "Expecting Money: The Essential Financial Plan for New and Growing Families," tells CNBC Select.
A substantial payment, even if you can't pay the whole balance, will be reported to the credit bureaus. "The next time your scores are calculated, it will be on that new balance," Sandberg says.
"The general rule of thumb," Sokunbi says, "is to keep your credit card utilization at 30% or less of your available credit."
Even if your tax refund isn't enough to completely write off your credit card debt, you can still make a sizable payment and enter the fast lane to earning a good credit score. This may help you qualify you for a balance transfer credit card, to which you can transfer your remaining debt and pay it off with no interest for a certain period of time.
If your score is already good enough to qualify for a balance transfer credit card, now may be the time to apply for a 0% interest period credit card.
For a long interest-free period, consider the Citi Simplicity® Card with its introductory 0% APR for the first 21 months on balance transfers (then 14.74% to 24.74% variable APR) or the Discover it® Balance Transfer with its 0% APR for the first 18 months (then 13.49% to 24.49% variable APR).
If you want to minimize fees, consider a no-fee balance transfer credit card, like the Chase Slate® Credit Card or Amex EveryDay® Credit Card, both with a 0% APR for the first 15 months on balance transfers (then 16.49% to 25.24% variable APR for the Chase Slate or 12.99% to 23.99% variable APR for the Amex Everyday). As a rule of thumb, read the fine print before requesting a balance transfer. (Learn how to make the most of your balance transfer.)
Walking away from a big chunk of debt lowers your emotional and psychological stress and frees up the resources to move on with your life.
"A vacation could be fun!" says Sokunbi — as long as you're on top of your debt and bills.
With less debt, you may qualify for a travel rewards credit card that pays you back for such adventures. The no-annual-fee Capital One® VentureOne® Rewards Credit Card lets cardmembers earn 5X miles on hotel and rental cars booked through Capital One Travel℠ and an unlimited 1.25X miles on all other purchases, making it a solid choice for everyday use.
Unless you have other bills that you are behind on, bills that are in collections or you don't have an emergency fund for other unexpected expenses, your tax refund is best used to catch up on paying off credit card debt.
"Your tax refund can give you an important boost toward reaching your savings goal." McClary says. "Experts recommend having at least three months of net income set aside in a savings account, and most Americans are short of that goal."
When it comes to financial decision-making, it's important to make the best use of your tax refund, or hard-earned money. "Since folks have just gathered all their financial information from 2019 to do their taxes, it's a great time to get their financial house in order and make progress toward their financial goals in 2020," Byron says.
Information about the Discover cards, Chase Slate® Credit Card, and Amex EveryDay® Credit Card has been collected independently by CNBC and has not been reviewed or provided by the issuer of the card prior to publication.
For rates and fees of the Amex Everyday® card, click here.