How to Use a Tax Refund to Boost Your Credit Score

If you're one of the two-thirds of Americans who expect to receive a tax refund this year, you may be tempted to splurge on a new pair of heels or to book that romantic vacation you've been talking about for years. But if you're saddled with debt, your best bet is to use the windfall to shore up your finances. While every individual's situation is different, here personal finance experts share the best ways to pay down your debt with your tax refund: what you should tackle first, how you should divide the refund, and how each strategy will help boost your credit score.

Pay down high-interest debt.

Examine the interest rates on your mortgage, credit cards, and student loans, and vow to pay down the debts that carry the highest interest rates first. "This is most likely credit cards or personal, unsecured loans," says Chip Wieczorek, vice president and wealth advisor at The Provident Bank in New Jersey. For example, if you have two credit cards that each carry a $1,000 balance, one with a 24-percent interest rate and one with a 13-percent interest rate, you'll save more than $900 in interest by paying off the 24-percent credit card first while paying the minimum balance on the other card. Before paying down tax-deductible debt (such as a mortgage, student loan, or home equity line of credit), make sure you have paid down your credit cards and other debt that does not confer tax benefits. Since 30 percent of your credit score is based on how maxed out your credit cards are, paying down debt will give your score a big boost.

Establish an emergency fund.

Ideally, you should have between three to six months of living expenses saved in an emergency fund, says Schwab branch manager Kristie Leatherberry. Should you fall on hard times and all of your cash is locked up in your home or invested for the long term, it will be tough to come up with much-needed cash. That's why a rainy day fund is essential. Should your car break down, you won't need to take out a loan to pay the bill. That's important because new credit can ding your credit score (not to mention add interest costs).

Catch up on unpaid bills.

If you've got a stack of bills you haven't been able to pay, use your refund to get ahead. "This will obviously stop the late fees from being added on, as well as the negative notations on the credit report" for not paying your bills, says Gail Cunningham of the National Foundation for Credit Counseling. That's because approximately 30-35 percent of your credit score is determined by whether or not you pay your bills on time.

Maximize retirement savings.

Once you've paid down debt, or if you didn't have any debt to begin with, your best bet is to invest the windfall. "Use your refund to jump-start your retirement savings by contributing to or opening a traditional or Roth IRA," suggests Leatherberry. Among Americans in the 50+ age bracket, 31 percent plan to use their tax refund to contribute to retirement savings, according to a survey from Charles Schwab. Those who are younger can benefit even more from investing their refund. Still, if you have outstanding debt, use your refund to pay the debt off first – since that will maximize your credit score.

This year, promise yourself that you'll use your tax refund to boost your credit score by applying it to pay down debt. The benefits of being debt-free will last longer than a quick romantic getaway or a pair of new shoes. Plus, you'll reap the benefits of a higher credit score, which can potentially save you thousands of dollars on an auto loan or mortgage.

This article is provided for general guidance and information. It is not intended as, nor should it be construed to be, legal, financial or other professional advice. Please consult with your attorney or financial advisor to discuss any legal or financial issues involved with credit decisions.

Published by permission from ConsumerInfo.com, Inc.  © 2013 ConsumerInfo.com, Inc.  All rights reserved.