With tax refunds hitting bank accounts, many people already have some idea in mind of how to use the money. Among those? Buying a car.
However, that might not be the smartest thing to do with your refund, especially if you have one in working order and are simply looking to upgrade. It’s easy to blow through a tax refund, even if it’s thousands of dollars, because the money goes out much faster than it comes in for most of us. Why put it down on a car purchase, if you don’t have to?
We’ve spoken with a few tax experts about what they think are the best uses for your refund… and surprise (or not), they think a car should not be on the list unless it’s a priority need.
Tax Refunds are Not Free Money
It’s easy to think because you get a tax refund that it’s free money. In fact, many people blow through their refunds for that very reason.
But — and I’m sorry to spoil this for you — it’s actually not.
It’s money you’ve overpaid to the IRS because of incorrect or overstated withholdings. In other words, you’ve worked for that money, and it’s owed to you. The government is just returning it.
Unfortunately, that doesn’t stop people from blowing through it, according to a money study by Qualtrics for Credit Karma.
Dealers Are (Strategically) Offering Discounts
If there’s one thing dealerships know how to do, it’s to lure buyers in. They know the tax refunds are due to hit the bank in February and March, so they tailor their ads, blogs, and promotions to make deals sound as if they’re too good to pass up. In fact, marketing agencies drive them to do so beginning in January. And it works.
In 2024, used-car sales were up 5% more than the year prior during this specific time period, according to Cox Auto, Inc.
A Smart Way to Budget for a Car
If you decide that a car purchase is necessary, following the 20/4/10 rule can help keep your finances in check. This guideline suggests putting down at least 20%, financing for no more than 4 years, and ensuring your monthly car expenses (including insurance) stay under 10% of your take-home pay.
This approach helps prevent you from overextending yourself financially while keeping your loan manageable. If your tax refund helps you meet the 20% down payment, that’s great — but don’t let it push you into buying a car that stretches your budget too thin.
But, Do You Really Need That Car?
The idea of saving money is tempting. It really is. It’s why many people love to take advantage of deals and savings when they come up. But, before you take your tax refund and head down to the local dealer, take a minute or two and think about whether you really need a new (or new to you) car.
Is it a need? Or is it a want? Jen Swindler, owner and advisor at Money Illustrated, says if it’s a top priority goal for you, “then putting some tax refund money towards purchasing a car is okay, especially if [you] are going to have an affordable monthly payment.” That payment, she specifies, should not exceed 10% of your take-home income.
Here’s Something to Consider Instead
Stacy Miller, founder and CEO of BayView Financial Planning, stresses the importance of adjusting your W-4 withholdings to ensure you get the most out of your paycheck. That extra money can be useful today instead of next year.
Swindler and Miller also offer some financial advice for taxpayers who received or will receive a refund this year. One is to pay down high-interest consumer debt. After that, put the money in savings, particularly your emergency fund, which should contain “3-6 months of non-discretionary expenses,” per Swindler.
Then, Swindler says to note whether taxpayers are “on track to contribute at least 10% of income to retirement accounts” or even max out their Roth IRA accounts, and if not, that’s where the money should go.
It can be a relief to see a tidy sum hit your bank account in the early part of the year, especially if you spent a lot for the holidays. However, before you go out and spend it on a new or used car, take the time to evaluate your options and whether you really need that vehicle. If you do need one, make sure you get the best bang for your buck by shopping around, and don’t be afraid to negotiate at the dealership; there’s often a lot of wiggle room built in.