What’s the Best Tax Refund Use: To Pay Debt or Save?

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In 2023, the average tax refund was $3,145 according to the IRS. So, if you’re one of the millions of taxpayers who expect a refund when you file your taxes this year, it’s important to have a plan before that cash arrives in your bank account or mailbox.

If you’re strategic about how you use the cash you receive back from the federal government, it could set you up for a more successful year to come. Yet even if you decide to be responsible with your tax refund, you still have to figure out the best way to apply your money. Depending on your situation, you might need to choose between paying down debt or saving money for the future.

The following tips can help you decide the options that make the most sense for you.

Reasons To Pay Down Debt With Your Tax Refund

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Using your tax refund to lower your debt offers several possible benefits. Here are reasons you may want to consider paying down debt with the cash you get back from Uncle Sam.

High-Interest Debt

When you owe high-interest debt, like credit card debt and some personal loans, it can be difficult to pay down your balances since such a large portion of your payment goes toward interest. According to the Federal Reserve, the average interest rate on credit cards was 22.77% in Q3 2023 (for accounts that assessed interest).

Recommended Low-Interest Credit Cards

Credit Card	Intro APR	APR	Learn More
Wells Fargo Active Cash® Card Apply Now Rates & Fees	0% intro APR for 12 months More Info 0% intro APR for 12 months from account opening on purchases and qualifying balance transfers. 19.49%, 24.49%, or 29.49% Variable APR thereafter; balance transfers made within 120 days qualify for the intro rate and fee of 3% then a BT fee of up to 5%, min: $5.	19.49%, 24.49%, or 29.49% (Variable)	Apply Now Rates & Fees
Chase Freedom Unlimited® Apply Now	0% Intro APR for 15 months More Info This card allows new cardholders to save money with an introductory 0% interest rate on new purchases and balance transfers for the first 15 months of account opening. After the introductory period, a 19.74% - 28.49% variable rate will apply. Balance transfers made within the first 60 days of account membership will be charged a balance transfer fee of either $5 or 3% of the amount of each transfer. After 60 days, that balance transfer fees increases to either $5 or 5% of the amount of each transfer, whichever is greater	19.74% - 28.49% (Variable)	Apply Now
Wells Fargo Reflect® Card Apply Now Rates & Fees	0% intro APR for 21 months More Info 0% intro APR for 21 months from account opening on purchases and qualifying balance transfers. 17.49%, 23.99% or 29.24% variable APR thereafter; balance transfers made within 120 days qualify for the intro rate, BT fee of 5%, min: $5.	17.49%, 23.99% or 29.24% (Variable)	Apply Now Rates & Fees
Citi Double Cash® Card Apply Now Rates & Fees	0% for 18 months on Balance Transfers More Info Balance Transfer Only Offer: 0% intro APR on Balance Transfers for 18 months. After that, the variable APR will be 18.49% - 28.49%, based on your creditworthiness.	18.49% - 28.49% (Variable)	Apply Now Rates & Fees

Personal loans with 24-month terms had an average interest rate of 12.17% during that same time period. But it’s important to shop around and compare rates. Some personal loans feature APRs as high as 35.99% and may add on expensive origination fees as well.

Using a tax refund to reduce debt with high interest rates could save you a lot of money. With credit cards, paying down your balance could also reduce the size of your monthly payments—offering potential financial relief throughout the year if you’ve been struggling to keep up with your payment obligations. And even if your refund isn’t large enough to wipe out all of your debts, it could be a great way to kick start a new debt payoff strategy and start moving your finances in a better direction.

Potential Credit Score Improvement

When you pay down debts with your tax refund, it might also improve your credit score. This is especially true if the debts you pay down are revolving credit card balances.

In general, paying down credit card balances will reduce the credit utilization ratio on your credit report. (Note: Credit utilization describes the percentage of your credit card limits in use.) As your credit utilization ratio declines, your credit score typically increases in response.

Paying off an installment loan, by comparison, like a personal loan, car loan, or a student loan may not have as much impact on your credit score. Although reducing the number of accounts with balances on your credit report can technically be good for your credit score as well, this credit scoring factor isn’t as influential over your credit score as your credit card utilization ratio. So, if your goal is credit score improvement, paying down credit card debt is the better strategy.

Reasons To Save Your Tax Refund

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Although paying down debt offers undeniable benefits, saving money can be wise as well. Below are a few reasons to think about saving either a portion or all of your tax refund instead of applying it all towards debt.

No Emergency Fund

Not having an emergency fund can leave you in a vulnerable place if life doesn’t go as planned. Most financial experts recommend maintaining at least three to six months’ worth of income in emergency savings for unexpected expenses. Research from the Consumer Financial Protection Bureau (CFPB) shows that 40% of consumers without an emergency fund have past-due debt.

Tip: If you decide to use your tax refund to create an emergency fund, consider opening up a high-yield savings account to help your money grow behind the scenes. Keeping emergency savings in a separate bank account might benefit you as well—potentially offering a higher interest rate and reducing the temptation to spend your savings when you shouldn’t.

Recommended High-Yield Savings Accounts

Bank Account	APY	Features	Learn More
BrioDirect High-Yield Savings Account Open Account	4.85% More Info *Annual Percentage Yield (APY) is variable and is accurate as of 11/15/2024. Rate is subject to certain terms and conditions. You must deposit at least $5,000 to open your account and maintain $25 to earn the disclosed APY. Rate and APY may change at any time. Fees may reduce earnings.	$5,000 min. deposit No monthly fee	Open Account
Axos ONE® Savings and Checking Bundle Open Account	Up to 4.86% More Info Earn up to 4.86% APY on savings, and 0.51% APY on checking when you meet requirements.	No minimum deposit No monthly fee	Open Account
SoFi Checking and Savings Open Account Member FDIC Member FDIC	0.50% - 4.00% More Info SoFi members with Direct Deposit or $5,000 or more in Qualifying Deposits during the 30-Day Evaluation Period can earn 4.00% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. There is no minimum Direct Deposit amount required to qualify for the stated interest rate. Members without either Direct Deposit or Qualifying Deposits, during the 30-Day Evaluation Period will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Only SoFi members with direct deposit are eligible for other SoFi Plus benefits. Interest rates are variable and subject to change at any time. These rates are current as of 12/3/24. There is no minimum balance requirement. Additional information can be found at http://www.sofi.com/legal/banking-rate-sheet.	No minimum deposit No monthly fee	Open Account
CIT Bank Platinum Savings Account Open Account	4.35% More Info Earn 4.35% APY on balances over $5,000. Balances of less than $5,000 earn 0.25% APY. Annual Percentage Yield is accurate as of December 20, 2024. Interest rates for the Platinum Savings account are variable and subject to change at any time without notice.	$100 minimum deposit No monthly fee	Open Account

You Have Low-Interest Debt

Another reason to consider saving your tax refund is if you only have low-interest debt. In recent months, consumers in the United States experienced rising interest rates on credit cards, personal loans, mortgages, auto loans, and other financing products. The rising interest rates were in response to a series of increases in the federal funds rate—an effort by the Federal Reserve to bring high inflation under control.

Yet before these interest rate hikes, many consumers were able to qualify for fixed-rate loans that featured much lower APRs. So, if you have no credit card debt and the only debt you have is a mortgage, auto loan, or another type of installment loan that features a low interest rate, you might not want to pay down those types of debts with a tax refund at this time.

Instead, it might make sense to look for low-risk savings products with annual percentage yields (APYs) that can beat the interest rates you’re paying out to creditors. For example, if you’re only paying a 2.9% APR on a mortgage, many of the best CD rates feature APYs that exceed that interest rate. Depending on your risk tolerance, you might want to consider other investment products as well. (Tip: You can speak with a financial advisor for guidance if you’re not sure which option is best.)

What’s the Best Way To Use Your Tax Refund?

With this year’s tax deadlines fast approaching, it’s a good idea to decide how to make the most of your tax refund before you file your tax return. The catch is that every situation is different. So, you’ll need to evaluate your finances to figure out the right option for you.

It might make sense to use 100% of your tax refund to pay down debt. If you’re spending a lot of money on interest fees every month or if you’re feeling stressed about your ability to keep up with your monthly credit card payments, this approach could make sense.

On the other hand, dedicating some or all of your refund toward savings might be more appropriate. If you need to beef up your emergency savings or if you only have low-interest debts, you’re more likely to fall into this category.

The good news is that whether you decide to save your tax refund or use it to pay down debt, you’re probably not making a bad choice. In either scenario, you’re likely to save money on interest and eliminate a bit of financial stress in the process.