Tax refunds will begin arriving soon.
And that means many Americans may be looking for a new or used vehicle on which to spend the money they get back from Uncle Sam.
Of course, you should not spend refund money on a vehicle if you have other financial needs or your budget can’t absorb the monthly payments. But with the average refund of about $2,550 reported last year by the Internal Revenue Service – more than $3,000 among the earliest filers – making a car purchase with your tax refund might be tempting.
For those inclined to spend, the average refund could be enough to cover about half of the 20 percent down payment financial experts recommend on a $27,000-$30,000 new or used vehicle.
And a recent report by Edmunds.com car research and shopping website suggests that the average $2,550 refund would cover about two-thirds of the average down payment for a new vehicle, around $4,000, and most of the average down payment for a used vehicle, about $3,000.
If you do plan to spend your tax refund on a vehicle, we have a half-dozen suggestions on how the extra money may help you make the purchase or payments:
- Use the money as additional down payment to reduce the amount of financing for your purchase, possibly resulting in smaller monthly payments with less budget impact. Doubling your down payment to $6,000 on a $22,500 (average) used vehicle financed for 60 months at 10% interest could reduce your monthly payment more than $60 to from about $414 to just over $350 based on our finance calculator. That’s an annual savings of more than $700!
- Pay down an existing car loan by using your tax refund to cover all or part of the balance on your vehicle loan or make several extra monthly payments so you are carrying less debt. A $3,000 refund, for example, would cover about five months of the average monthly new-car payment and more than six months of a used-car payment based on Credit Karma 2020 data.
- Buy a really inexpensive used vehicle. With a bit of searching, an average refund could go a long way toward buying a low-priced used car that meets basic needs. For help on this, see results of an iSeeCars.com study that identifies the best used cars to buy under $5,000 and under $10,000.
- Make a large drive-off payment on a new-car lease, since applying a larger down payment to your lease could reduce the monthly amount and ongoing budget impact.
- Refinance your current financing if your credit rating has improved, enabling you to reduce the interest you are paying, i.e., structure a better loan. Using a $3,000 refund to reduce your financed amount from $11,250 to $8,250 for the remaining 30 months of a loan at 7.5% interest instead of 10% would result in more than $1,100 in interest savings, our calculator shows.
- Fix or upgrade your current vehicle, because keeping a recent-model-year vehicle well maintained could allow you to drive it longer than you might otherwise. Well-maintained vehicles can last 200,000 miles or more, experts say, almost 15 years at the average annual distance of 13,500 miles. Electric vehicles can last even longer, as much as 300,000 miles, Car and Driver reports.
Making a sound financial choice is even more important than usual in the midst of a global pandemic – few people have $3,000 to spare – but understanding your options will help you make one that won’t leave you with buyer’s remorse or a hole in the budget where your tax refund should have gone.
So, whether you end up with a new or used vehicle, buying or leasing, catching up on monthly payments or getting ahead, refinancing your current contract or simply upgrading your vehicle, happy car shopping this tax season.
But don’t forget to file your taxes by April 15.
* These statements are informational suggestions only and should not be construed as legal, accounting or professional advice, nor are they intended as a substitute for legal or professional guidance. Please consult a tax professional.