Your tax refund could help you improve your credit score. (iStock)
Tax day for 2019 has been delayed due to the coronavirus crisis, with taxpayers now allowed to file their returns and pay the IRS as late as July 15, 2020. For millions of Americans, however, there won't be a bill to pay – instead, they'll receive a tax refund.
Up to 70 percent of Americans get money back from the IRS after filing and the average refund for the 2018 tax year was $2,881. If you're among the majority expecting cash, using it to improve your credit score is one smart option. This score impacts many aspects of your financial life, from whether you can borrow to where you can live to the cost of credit and car insurance. Improving it can pay dividends.
So how can you put your tax refund to work in raising your credit score? Here are four ways it could help.
4 ways to boost your credit using your tax refund
Get current on late payments
Creditors report late payments to credit reporting agencies after you're 30 days late, 60 days late, or 90 days late. The more delinquent you are and the more delinquencies on your record, the worse the impact on your credit score.
If you're behind on paying, bring the accounts current so you don't get any more red marks on your credit record. You may want to call your creditors and try to negotiate a deal to pay what you owe in exchange for the removal of the negative information. While not all lenders will agree, it doesn't hurt to ask.
Paying your late bills off also allows you to avoid having accounts sent to collections, which is even worse for your credit score than simply being tardy.
Pay down your credit card balances
Credit utilization ratio is one of the most important components of your credit score. It's calculated by comparing the amount of credit you've used versus the total amount available. A card with a $5,000 limit and a $1,000 balance would have a 20 percent utilization ratio, calculated by dividing $1,000 by $5,000.
A ratio above 30 percent hurts your credit score, while consumers with the best scores typically keep their credit usage to around 10 percent or less of available credit. If you've got large balances, paying them down could improve your ratio and give your score a boost.
Use it as a deposit to get a secured credit card
You can't improve your credit score unless you've been able to borrow and develop a positive payment history. Unfortunately for consumers with poor credit or no credit history, many creditors aren't willing to lend to you – which means building credit isn't possible.
The good news? You can get a secured credit card if you're able to put down a deposit equal to the amount of the credit line. A tax refund can provide the funds to do that.
Look for a secured card with no fees that report to the major credit reporting agencies and use it to make small purchases. Then pay your balance in full each month to avoid interest charges. Over time, your secured card will help you develop a payment record that raises your score.
Use it as collateral for a secured loan
The mix of credit available to you is also a key component of your credit score, so it's a good idea to have a few different kinds of credit on your record. If you already have a credit card, getting an installment loan could achieve this goal. An installment loan is one paid back on a set schedule with fixed monthly payments.
If your credit isn't good enough to qualify for an unsecured installment loan, you could use your tax refund as collateral to apply for a secured one. Many banks, credit unions, and online lenders offer loans that require a deposit equal to the amount you borrow. If you get one and pay it back on time, this can be a big boon to your credit score.
What not to do with your tax refund
Using your tax refund to improve your credit score can pay big dividends as a higher score lowers costs in the future. But if you decide not to take this approach, look for something else you can do with the money that will improve your long-term situation.
Since a tax refund may be the biggest cash influx you get outside of a paycheck, don't waste the opportunity to use it wisely. Avoid purchases that don't appreciate in value, such as buying clothes or electronics. Using it for a vacation is also a bad idea as the money will be spent with nothing to show for it. And it's usually not wise to use it as a down payment for a large purchase you go into debt to make, as this would leave you with another financial obligation to fulfill.
How else can you improve your credit score
Whether you claim a student loan interest deduction, the earned income tax credit, or other tax breaks, maxing out your tax refund is a good idea so you can get the maximum cash from the IRS to accomplish your goals.
But even if your tax withholding doesn't entitle you to a refund, you can still boost your credit by simply paying bills on time, paying down debt and keeping card balances low, applying for a mix of different kinds of credit, and not applying for too much credit at one time.
If you act like a responsible borrower with good control over your debt and spending, credit scoring formulas will reward your efforts.