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Should You Use Your Tax Refund to Pay Down Your Student Loans?

Maurie Backman, The Motley Fool

Now that the April 15 tax deadline is behind us, many filers will likely see their refunds hit their bank accounts in the coming weeks. As of early April, the average federal tax refund for the 2019 filing season was $2,833, according to the IRS, and if you're expecting a similar payday, you may be contemplating using it to chip away at your nagging pile of student debt.

It's estimated that 71% of college graduates carry some sort of educational debt, and all told, Americans are on the hook for more than $1.5 trillion in student loans. If you borrowed money for college, you're probably aware that the longer you carry that debt, the more interest you'll pay. And if you borrowed for college privately, that interest could be substantial. As such, it might make sense to use the cash you get back from the IRS this spring to pay down a chunk of your student debt. But before you do, ask yourself the following two questions.

Young woman at laptop looks at documents

Image source: Getty Images.

1. Is my emergency fund complete?

We all need emergency savings for when life throws unwanted financial surprises our way. Without an adequate amount in the bank, you'll have no choice but to use debt the next time an unplanned bill pops up that your paycheck can't cover.

How much money do you need for a fully loaded emergency fund? At a minimum, three months' worth of essential living expenses, but ideally, more like six months' worth. This way, you're also covered in case you lose your job and are forced to go without a paycheck for a period of time.

Your emergency fund should actually trump all other financial priorities you have, and that includes paying down student debt. Therefore, if you're lacking a safety net, you should stick your tax refund in the bank so you have that safety net.

2. Am I carrying high-interest credit card debt?

Though student debt can be stressful and annoying, it's generally considered a healthy kind of debt. This especially holds true if your loans are federal, since those come with relatively low interest rates. On the other hand, if you're carrying a credit card balance, you should know that it's the sort of debt that's unhealthy, and chances are, it's costing you more in interest than your student loans. As such, it makes more sense to use your tax refund to pay down your credit card debt before tackling your educational debt.

Carrying a high credit card balance won't just cost you money in interest; it could also hurt your credit score. Specifically, using too much of your available credit at once could drag your score down, thereby making it more expensive (if not impossible) to borrow money the next time you need to.

That said, if you owe money on a credit card but happen to have a remarkably low interest rate -- one that's lower than what you're paying on your student loans -- then it makes sense to chip away at your costlier debt, which, in this case, is the educational variety. Otherwise, get rid of credit card debt first, and then work on tackling those pesky student loans.

Getting rid of your student loans

If you're in a good spot savings-wise, and you're not carrying costly, unhealthy debt, then using your tax refund to pay off a chunk of your student loans is a wise move. If that's not the case, however, then you don't need to give up on the idea of getting rid of that debt ahead of schedule. You could always try getting a second job on top of your primary one, and using the earnings to chip away at your student debt. Or, you can cut expenses to free up cash to pay it down. Your tax refund doesn't have to be your sole source of extra money during the year, especially if you're willing to make an effort to knock those loans out of the picture.

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