How Your Tax Refund Could Improve Your Credit Score

How Your Tax Refund Could Improve Your Credit Score article image.

A tax refund is a golden opportunity to give your finances a boost, and one of the most effective strategies is to focus on your credit score. You can use your tax refund to improve your credit scores by paying down debt, bringing debt payments up to date or starting an emergency fund to protect yourself from surprise expenses.

With strong credit, you'll be more likely to qualify for loans, credit cards and even an apartment lease. You'll generally receive more competitive interest rates, too, saving you money over time.

The average tax refund for the 2019 filing season was $2,975, according to the most recently available data from the IRS. That's a solid amount to put toward improving your finances.

Here's how to fortify your credit using a tax refund.

Pay Down Debt

Using your refund to pay down revolving credit card balances is one of the best ways to boost your credit scores in a flash. That's because as you knock out debt, your credit utilization ratio—the percentage of available credit you're using—drops too. This ratio plays a major role in determining your credit scores.

Experts recommend keeping your utilization ratio below 30%, but for top scores, below 7% is ideal. To help improve credit, use at least a portion of your refund to make a dent in your debt, and keep your utilization low going forward.

If you have multiple credit cards, prioritize paying off the ones with the highest interest. That way you'll get the added benefit of saving money on interest charges.

Catch Up on Late Payments

If you recently missed a credit card or loan bill, you may be able to use your tax refund to catch up and avoid a hit to your credit scores.

Credit card issuers typically don't report late payments to the credit bureaus until a full billing cycle, or about 30 days, has elapsed. Use your tax refund to make a payment before those 30 days are up, and you may avoid a late payment appearing on your credit report. That's crucial, because payment history is the most important factor in your credit scores.

Additionally, your issuer can charge you up to $29 in fees the first time you pay late, and $40 if you pay late again within the next six billing cycles. But if you don't regularly miss payments and you can catch up right away, the card issuer may waive the late fee.

Consider Applying for a Secured Card

Maybe you're looking to build credit from scratch, or to bounce back from a blow to your credit scores. Your tax refund can give you the flexibility to open a secured credit card, which can help you establish credit history with regular, on-time payments.

Secured cards work similarly to traditional credit cards, but they require a refundable security deposit that typically becomes your credit limit. This deposit acts as collateral for the card issuer, protecting it in case you don't keep up with payments.

You don't even have to use your full tax refund to open up a secured card. You can usually choose your deposit amount, which for many cards starts at $200.

Secured card issuers typically report your payment history to one or more of the three major credit bureaus (Experian, TransUnion and Equifax), so responsible use can help you build a positive credit history. That means making all payments on time, using as little of your available credit as possible and paying off your charges in full every month.

Build an Emergency Fund

Starting or growing a savings account for emergencies won't have an immediate effect on your credit scores. But it will safeguard your scores from the effects of going into debt to cover an unforeseen expense, like a medical bill or car repair.

The ideal amount to save depends on the predictability of your income and expenses, and on your individual lifestyle. A healthy emergency fund generally should cover three to six months of basic expenses, but you might decide you'd feel secure with more or less. Your tax refund can give you a jump-start on your savings account, and you can contribute a small amount monthly thereafter to hit your goal.

Once you build your savings, you'll be able to avoid using a credit card in a pinch. But once you've dipped into your fund, make sure to replenish it as soon as you can.

Put Your Tax Refund to Work

A tax refund might be the biggest windfall you receive this year, so use it wisely.

While you can—and should—spend a portion of it on something you enjoy, make sure the majority of your refund helps you make progress on financial goals that would have been difficult to achieve otherwise. Strong credit is one of the most powerful financial tools at your disposal. Make improving it your focus at tax time.