If you have a tax refund headed your way this year, you might be wondering how you should spend it.
The responsible angel on one shoulder says to use it wisely, like paying off some of your line of credit balance. The reckless devil on the other says it’s not worth it. After all, what’s the point if you can’t bring your balance to zero? You might as well splurge on something fun.
This black-and-white thinking can trip up a lot of people, and the way you’re billed for a line of credit could be partly to blame. With a minimum payment that lets you off the hook from your entire bill, you might think it’s okay to pay less than you need.
But even a little payment can make a big difference.
The Minimum Payment Can Be Confusing
Any revolving account (a credit card or line of credit) comes with a minimum payment. This is the smallest amount of money your lender expects you to pay each month.
How much the minimum is depends on your lender. If you borrow a line of credit from a lender like Fora, your minimum payment may include an interest charge based on your outstanding principal balance and a contribution towards your principal.
This winds up being a flat fee; however, some lenders may calculate your minimum as a percentage of your outstanding balance.
If you aren’t sure how your lender determines your minimum, this information should be available in your loan contract. You may also call your lender to learn more about your rates and terms.
With such an emphasis on the minimum, it’s easy to start thinking about it like it’s the only payment, too. But in reality, you can pay off as much of your balance as you can. In fact, lenders like Fora encourage it.
3 Perks to Paying More Than the Minimum
Paying more than the minimum comes with a lot of perks.
- For one thing, you’ll clear some of your limits, so you have more credit available in case another emergency expense comes along.
- For another, you could get out of debt faster. Paying off your principal reduces what you have left to pay.
- You could lower your utilization ratio, which may affect your credit score if your lender shares your payment history with a credit bureau.
The Best Reason to Use Your Refund on a Line of Credit
While the perks above are all nice, there’s one reason why financial advisors recommend paying as much as you can for every statement. It comes down to interest.
In many cases, interest gets charged on your outstanding balance by a specific APR (Annual Percentage Rate). You can’t change how much your APR is once you lock into a contract. But you can lower your balance.
Lowering your balance means your APR can’t compound as high as it would with a higher balance. You’ll still accrue interest but not as much.
To a perfectionist, this might not seem like it’s worth it, but it can make a huge difference long-term — especially if you have a high APR. Keep this in mind long after you use up the last of your refund. Budget so that you pay more than the minimum every month.