Mellody Hobson: What to Do With Your Tax Refund

Many Americans are already eagerly awaiting a big tax refund. The Internal Revenue Service says refunds are up $200 on average this year, and the typical refund is nearly $2,500.

So what should you do with all that money? "Good Morning America" financial contributor Mellody Hobson offered some tips on how to use that money wisely.

Pay Off Credit Cards

This could be the most important way for most Americans to use their refund, says Hobson. The average American has $8,562 in credit card debt. If you put that average tax refund of nearly $2,500 toward paying off your credit card debt, you would shave off almost three years of payments and more than $3,600 in interest payments.

Contribute to IRA

If you're in your early 30s and put your entire refund into an IRA that earns 9 percent interest -- a reasonable rate of return on most investments -- that average 2004 return of nearly $2,500 would grow into nearly $36,000 in 30 years. If you're older, it would still grow substantially before your retirement date.

Save for College

Investing your refund for your children's college education will save you a lot in the long term. If you invested that typical 2004 tax refund at that same 9 percent rate, it would turn into more than $12,000 in 18 years. That's a year's tuition at many colleges, or the cost of books, airplane tickets, a computer and other necessities over the course of an entire college career.

Pay Down Mortgage

Using that typical 2004 refund to make an extra mortgage payment can save you time and money. Say you have the average 30-year mortgage at $150,000 at a rate of 7 percent. Applying your refund would trim a full two years of payments and more than $16,000 in interest.

Refinance Mortgage

With the average mortgage rate on a 30-year fixed mortgage at 5.35 percent, it's often much too low to pass up. If your rate is at least one point higher than that rate -- if it is 6.35 percent or above -- use that refund to pay for any refinancing costs.

Save for the Holidays

The typical American spent $835 on holiday gifts last season, so save that part of your tax refund for next year. You can avoid putting those gifts on your credit card and paying for them next March.

Mellody Hobson, president of Ariel Capital Management (arielmutualfunds.com) in Chicago, is "Good Morning America's" personal finance expert. Ariel associates Matthew Yale and Aimee Daley contributed to this report.