Tax Refund

April 20th, 2009, by

Q: I have approximately $22,000 worth of debt. I feel an urgent need to get out from under it now. I have a 13-year-old son, and we currently live in a high-crime area, where boys between the ages of 12 – 22 are getting killed at alarming rates.

I am a temporary employee at a Fortune 500 company, where I have worked since my son was born. I want a home that I can call my own.

I have two student loans. One is currently $15,000 and the other is $2,000. I pay $180 and $50, respectively, per month. I have a bunch of collection accounts that total approximately $5,500. I received a tax refund for approximately $8,000 and I wanted to know what I should tackle with this money. Should I pay off the 13 or so written off/collection accounts or apply the money to the $15,000 loan?

Of course, I can’t pay them all with this money. I only wanted to apply $5,000 to $6,000 to debt and take $2,000 to $3,000 and get a car. I don’t own a car currently. I have two sons. The other one is 9 years old.

A: It’s great that you want to honor your debts. So, let’s break down how you might use the refund of $8,000. But before I do, please talk to a tax professional if you get a large refund every year without any material changes in your life. If you continue to get a large refund, year after year, you are essentially letting the government hold your money in an interest-free loan.

Okay, now about that $8,000. Here’s what I would do:

  • $2,000 – set aside for an emergency fund. You indicate you have a pretty stable job, but still you need some emergency money. Also, put another $500 away in what I call a “life happens fund,” especially if you get a used car.
  • $2,000 – pay off the one student loan. Just get rid of it. Don’t hold onto that debt like it’s a pet. Then, take the $50 you are paying on that loan and automatically put it into your emergency fund, which I want you to build up to at least three months’ living expenses.
  • $3,000 – use for the car. With two boys, try to get the best used car you can get for that amount of money. Please be sure to have a mechanic look over the car. You can’t afford to waste money on a lemon.
  • $1,000 – car insurance. In your neighborhood in New Jersey, you will probably have a relatively high annual car insurance bill. So, hold back this much to pay for at least the first year’s payment.

That’s it for the $8,000.

As for the $15,000, just aggressively pay it down. For now, don’t worry about those older debts. By no means am I telling you to walk away from those obligations, but they will have to wait until after you pay off the student loan.

With collection and defaults on your credit reports, you probably have low credit scores, which will make it difficult for you to qualify for a home. But don’t give up that dream. There are still some good programs for first-time home buyers. In fact, I want you to contact the Neighborhood Assistance Corporation of America or NACA, which is a nonprofit, community advocacy and homeownership organization. NACA has a homeownership program that may help you finally buy a house.

NACA has a home purchase program for members with no down payment and no closing costs. You also don’t have to have perfect credit.

Most important, I’m proud of you for not just blowing that money and wanting to pay down your debts. Good for you.

Last modified: April 26, 2011 at 10:59 am