How to Use a Tax Refund for a Used Car

6 Questions to Consider

2010 Subaru Forester
Subaru Forrester is a good choice for a used crossover with AWD. Wikimedia Commons

It’s that time of year. People are filing their taxes, getting a big refund, and thinking of buying a new-to-them used car. Here’s some advice on how to use a tax refund for a used car. Start by asking these six questions.

Do You Need a New Car?

Again, just to clarify, this means new-to-you car. Is the money from the refund burning a hole in your pocket? Is that why you want a new ride? However, if your car is on its last legs, it’s a good idea to use those forced savings called an income tax refund to finance your purchase.

Car broken down? Yes. Just bored with your car? No.

How Much of Your Refund Should You Spend?

Your average refund is probably going to run anywhere from $2,300 to $3,200 depending on where you live. Let’s go conservative and assume you have $2,500. Don’t invest the whole thing in your next used car. You'll want to set aside funds for a possible insurance increase and possible life emergencies.

Also, invest in getting the best used car. Use some of the tax refund money for a pre-purchase inspection of the used car you want to buy. It’s going to be $100 to $150 but it is money well spent. And, refuse to buy any used car when a seller won’t allow inspection.

Use about 60 percent of your tax refund towards the car.

Do You Let the Seller Know You Have a Refund?

After all, it might make you seem like a more serious customer if you can demonstrate you have the funds, right? Wrong. To a savvy seller it’s going to make you as a sure thing. The seller will know you have money burning a hole in your pocket. No seller is going to want to negotiate for better prices. They’re just going to see a rube wanting to be parted from his funds.

Never let the seller know the source of your funds before setting the final price.

Should You Use a Refund Anticipation Loan?

This can’t be stressed enough: don’t use one unless your car is absolutely dead and you need the money. A refund anticipation loan is similar to a cash advance or "payday loan," in that it is short-term loan made against an expected tax refund that carries a high interest rate. 

Your down payment from the tax refund is going to be eaten up by these fees. It reduces the power of your money if you are not patient and wait for the refund from the government. With direct deposit, the IRS says you can expect your money in about 21 days. You’re going to come out ahead if you wait.

Never use a refund anticipation loan as a down payment on a used car. Heck, never use a refund anticipation loan unless it’s for a true emergency.

Can I Start Searching for a Used Car Before Getting My Refund?

Absolutely because it will make you a smarter shopper. You can’t act impulsively if the funds aren’t in your bank account. You can find the car of your dreams (assuming it’s within your budget) and arrange the financing ahead of time. Regardless of when you buy a used car, you should always walk into the transaction knowing how you are going to pay for the car and what your monthly budget is going to be.

Preparation is smart whenever used car shopping.

Can I Use My Tax Refund to Get a Nicer Used Car?

Absolutely. Could the refund make a difference between a standard used car and certified pre-owned? The latter might be the smart choice, depending on how financially savvy you are. There are advantages to certified pre-owned depending on what kind of used car owner you are. Plus the premium for certified pre-owned used cars is dropping. They make more sense than ever.

If you have the spare cash to do so, treating yourself with an upgrade can be a nice treat.