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Do the Smart Thing With a Tax Rebate

What will you do with your tax rebate? Spending it now might make a nice late Christmas present, but doing something more prudent could end up making a much bigger difference to your finances.

To try to jump-start the flagging economy, it looks likely that Congress and the president will agree on a stimulus package that could get you a check for as much as $1,600. The idea is for people to turn around and put that rebate money back into the economy.

Yet while many people are hoping to turn their checks into HDTVs or other high-ticket purchases, you should consider improving your financial condition for the long term. With tough times ahead, a little forethought now will make things easier for you. If you're in debt, applying your rebate to pay it down might be the best move you can make.

Cut your debt
Many argue that the success of a stimulus package depends on consumers going on a shopping spree, but using the money to cut your debt can be a win-win both for you and for credit card issuers.

For you, the return is immediate. Right now, the average credit card rate is around 13%. So if you typically keep a balance of $1,600 on a typical card, you're paying more than $200 in interest every year. That's money that'll go back in your pocket if you pay off your debt.

Put another way, if you're making minimum payments to pay off a $1,600 balance, it'll take you more than 16 years to get it down to zero. Along the way, you'll pay more than $1,500 in interest -- nearly doubling your original debt. But here's a chance to pay that debt off with your rebate check.

Support the financial economy
Moreover, while credit card issuers need your business, they need the cash more. Bank of America (NYSE: BAC  ) found $2 billion to inject into Countrywide Financial (NYSE: CFC  ) last summer, but the planned takeover is an all-stock deal, reflecting the current cash crunch. Citigroup (NYSE: C  ) announced a $14.5 billion capital infusion last week.

Card issuers are starting to feel the pain of the slowing economy. For instance, Capital One (NYSE: COF  ) increased its write-offs for uncollectible payments last month. Any money they can get will be quite welcome.

As a result, it's possible that a stimulus package could be an indirect bailout of some financial institutions. Of course, it won't help all of them. While $1,600 isn't insignificant, it's probably not enough to help mortgage lenders like Fannie Mae (NYSE: FNM  ) , which cut its dividend and raised more capital in response to increasing mortgage delinquencies.

Focus on you
But your lender's financial condition shouldn't be a major consideration for you. In a slowing economy, the last thing you want to do is overextend yourself. Cutting debt now will pay dividends for years to come.

For more about taxes and cutting your debt, read about:


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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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