It’s officially tax season which of course means a lot of paperwork, searching for receipts, and trying not to toss out your W-2 with the junk mail. But for many of us, there’s often one dependable bright spot to an otherwise monotonous task: the tax return.
This year, if you’re thinking of putting whatever return the government grants you towards something responsible, like a new car, the following advice can help you make a smart financial decision.
Plan Your Vehicle Purchase
Even if your tax return is burning a hole in your pocket, you need to be careful to plan for the life of your vehicle purchase. If you’re not covering the entire cost of the vehicle with your tax return, there are a few smart ways to apply the lump sum.
We spoke to Rob Jupille, President of RTJ Financial Management in Santa Monica, CA, who offered his advice. As with any large purchase, explains Jupille, start with a cash flow analysis and budget to determine what kind of payment you can afford each month. “If there is a lump sum, as with a tax refund, buyers can apply it toward the loan to make their ongoing monthly payment manageable.”
Online personal finance tools like Mint are great for both budgets and cash flow analysis, says Jupille. “Once you take the time to input all your accounts, it will give you a pretty decent snapshot of where your money is going.” However, says Jupille, you’ll have to look at more than just one month to get a full picture of your finances over time — without several months’ financial information, you could either miss or inaccurately capture a large expense. “For those that are more manually inclined (and still get paper statements), there are a number of free spreadsheets available that cover most of the categories in a budget,” Jupille added.
Make a Smart Loan Decision
Most of us finance vehicle purchases, meaning we get a loan either from a dealership or from a private financial institution (like a credit union). It’s important to make an informed decision about your vehicle financing (we have more detailed advice here) because what may seem like small differences initially (a few percentage points in interest) can end up costing you a lot more money over the life of the loan. It’s particularly important to be wary when it comes to subprime loans.
A subprime loan — defined as a loan made to someone who might have a difficult time paying it back — can get borrowers into financial trouble quickly and can, in many cases, result in the borrower losing their car or even ending up underwater on their loan. Subprime loans, by definition, have higher interest rates (to provide incentive for the lender to lend to someone who statistically may never pay them back fully) and therefore increase the total price of purchases made using them. Approximately 20 percent of all auto loans are subprime, so if you’re planning a tax-return financed vehicle purchase this tax season, you’ll want to be aware of your loan options.
“Vulnerability to subprime loans is always a potential problem for some borrowers,” explains Jupille. “The easiest way to not fall prey to predatory lending (or pressure at the dealership) is educating oneself.” Start by knowing what your credit score is before you go to the dealership. Then, look up car loan rates for borrowers with credit score similar to yours, says Jupille. “This way,” he says, “if the dealership offers a much higher rate, you can comfortably negotiate or walk away.”
Incorporate Insurance Into Your Budget
We’ve talked about different ways to save money on your insurance policy, but paying the entire policy in full (rather than monthly) is one of the best ways to save. In our recent State of Auto Insurance study, we found that drivers who pay the full price of their policy up front save an average of $62 a year, or about $5 each month, compared with drivers who make monthly payments. “Most monthly plans include installment fees,” adds Neil Richardson, The Zebra’s resident insurance expert, “even though our report doesn’t really reflect it, making the difference between paying in full and monthly even larger. It’s also important to note that anyone looking to buy a car should get auto quotes before they sign any vehicle paperwork so they can properly budget for such a large purchase. Quoting ahead of time can help new car buyers avoid a major, unexpected surprise.”
For your financial health, you might consider applying some of your refund towards your next insurance policy.
Big purchases, like new (or new-to-you) cars can be thrilling, but before you take the leap, consider your other financial responsibilities. “Any ‘windfall’ like a tax refund should be applied where it has the highest impact,” explains Jupille. “If someone has a large amount of revolving debt at a high interest rate, they are better of paying those balances down and postponing the car purchase.” Paying down revolving debt will improve your credit score and therefore earn you better interest rates when you do buy, says Jupille, and it will improve your cash flow which might allow you to buy a better car in the future.