Financial Spring Cleaning

Using your tax refund and bankruptcy to get your financial house in order.

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Use Your Tax Refund to Spring Clean Your Finances. dblight/ E+/ Getty Images

It’s springtime, and that means time for spring cleaning. While we’re polishing the windows and beating the rugs, why not think about how we can spring clean our finances as well.

That brings me to another staple of springtime:  taxes. . .and tax refunds. Have you ever thought about using your tax refund to help get your financial house in order?

According to an article at Forbes.com, about 79% of tax returns generate a tax refund.

 Would you be surprised to learn that the average tax refund is $2,994? I was. 

It seems that a lot of people use the IRS as their savings bank, appreciating the arrival of that springtime nest egg each year.

I was curious. How do they use the money? A recent poll breaks down the spending like this:

  • 47% will use the money to pay bills
  • 49.6% will invest the money
  • 12.9% will spend it on living expenses
  • 9.9% will spend it on vacation or other non-essential purchases

See Forbes.com How Will You Use Your Tax Refund?

It's good to see that almost half of the respondents in the survey intend to use their refunds to pay down their debt. But what if, instead of using it to pay a few minimum credit card payments, you used it to eliminate your debt. Yes, sweep it out the door. 

What if you used the refund to discharge the debt in a bankruptcy case. A lot of bankruptcy attorneys see an increase in inquiries this time of year just because people anticipate having a little more cash available.

 After the frenzied spending of the holidays and the shock of opening those credit card statements later, some folks decide that the best use of that money is not necessarily to pay those monthly minimum payments, but to pay someone who can help them get a fresh start.  They hire an attorney and file a Chapter 7 or a Chapter 13 bankruptcy case.

I would put that squarely in the “investment” category. Why?  Because you’re using a little money now to save a lot in the future. Here’s how it works:

According to the 2007 Consumer Bankruptcy Project, the average credit card debt for a Chapter 7 filer was $26,267. 

If we take that number and calculate how long it will take to pay it off, we will find out how much in interest you would have to fork over. 

Let’s say your average interest rate is 18% and your minimum payment is 4% of the balance. Your minimum monthly payment on that amount of debt will total $1,050.68. It will take you 189 months -- that’s almost 16 years -- to pay it off, assuming you make no additional charges and incur no late fees. You will pay a whopping $11,873.95 in interest. You can check the figures yourself with Bankrate.com’s handy payment calculator.

If you filed a Chapter 7 bankruptcy today, you would save yourself having to pay back a total of $38,140.95. 

According to one estimate, the average cost of filing a Chapter 7 bankruptcy is about $1,500. See Too Broke to File Bankrutpcy? Part 1.  But compare that with the $38,000 you will not pay out over the next 16 years. The return on that $1,500 investment is huge!

 

Investments always come with risks. It is true that bankruptcy brings with it a hit on your credit score.  The bankruptcy case will appear on your credit report for up to ten years, but that hit be more short-term than you think. On average, we’ve found that it only takes about two years of clean financial living to bring your credit scores back into an acceptable range. At the end of those two years, most people are getting credit offers with rates comparable to those offered to people who never filed a bankruptcy case, good car loans and even mortgages.

But, we're not through yet. Let’s take it one step further. Let’s say that instead of paying out that $1,050 in minimums each month to your creditors, you invest that money in a mutual fund that pays 7% per year.

In 16 years, with inflation, your investment will total $212,679. Really. Check it out at with the investment return calculator at Bankrate.com.

Would you rather be $38,000 in the hole or richer by $212,000? 

So, as you scrub those floors and clean out the garage, consider whether it’s a good idea to do a little spring cleaning to get that financial house in order, too.