For some people, April is a nightmare. They discover they owe the federal or state government thousands in income taxes. For others, there is a celebration. They’re getting a big refund!
People in poverty don’t manage money well, as a general rule. For starters, they’ve never had enough that they thought beyond what they need to pay the bills. They may have tried having bank accounts, only to watch their few funds being eaten by fees. There often isn’t a “future” sense, where they plan for long-term purchases.
For a household in poverty, a windfall like a tax refund over $1000 means they can make a major purchase, something they couldn’t consider any other time of the year. The money may go towards a used car, or a new television, or a gaming system. Maybe they’ll plan a vacation to visit relatives. The money will be spent as soon as they get it.
Middle class families handle money much differently. They have bank accounts, credit cards, retirement funds. They know what their FICO score is. Before they borrow money, they’ve planned a budget and know how to pay it back.
Financial managers and bankers think like middle class people – they have a focus on money. So how do they think families should handle their tax refunds?
First, pay down any high-interest debt. This means clear those payday loans! (Nebraska has curbed those money suckers, but you can still get them online.)
The other high-interest debt people have is unpaid balances on credit cards. You may be paying 24% interest if you don’t pay in full every month. If you have bad credit, interest on credit card debt can be as high as 39%. You’re paying so very much for the privilege of charging a purchase, and each month you pay lots of interest, but very little of the price of what you bought.
Second, create an emergency fund. According to the Federal Reserve’s Economic Well-Being Survey, 37% of Americans do not have enough money to cover a $400 emergency expense. How can they handle a car repair or replace a tire? What if their child breaks an arm or a tooth? They would have to use a credit card, or hit up friends or family for the cash.
Financial experts say a family’s emergency fund should be three to six-months of their income. That is not a realistic amount of readily available cash. But a family should have around $1000 they could pull out of their bank account immediately. And that fund can save so much heartache and stress.
Third, pay on lower interest debts. Most of your monthly house or car loan payments go toward interest. Extra amounts you pay on loans go directly toward the principal, the amount actually borrowed. Paying extra means you dramatically move up the date your loan will be paid in full.
Fourth, pay your future self. Put your money into a retirement account, or a college savings plan. Or buy a certificate of deposit, which is earning a good interest rate right now. It is harder to access these funds, so there isn’t a temptation to spend.
Don’t overlook your mental health. Maybe you should go on a vacation or buy a new television. It’s your money. However you spend it is up to you.