Should You Utilize a Personal Loan to Pay Taxes?

If you don’t have enough money to pay your bill at tax time, you may consider a personal loan to pay taxes. It’s an option that works for some people but not everyone.

Here’s everything you should consider before borrowing money to pay your taxes.

Using a Personal Loan to Pay Taxes

If you have a tax bill you cannot pay, a personal loan may be an option. The IRS charges interest and penalties when you don’t pay your tax debt in full, so a personal loan to pay taxes with a fixed interest rate and payment could be a more viable option.

However, it’s not right for everyone. Here are the pros and cons to consider when you owe money on your taxes.

The Benefits of a Loan to Pay Taxes 

There are several benefits of using a personal loan to pay your tax debt, including the following.

• Avoid using your savings or emergency fund – Draining your savings or, worse yet, your emergency fund can be detrimental in the future. No one knows what the future holds. What if you lose your job or get sick? Without an emergency fund, you could be in a bad financial situation. If you use a personal loan to pay unpaid taxes, you can keep your savings account intact and have it available in an emergency.

• No collateral or property attachment – Personal loans don’t require collateral. This means you don’t have to put anything up for it, such as your house or car. This means you won’t lose your assets if you can’t pay. Of course, if you can’t make your payments, you should talk to your loan servicer immediately to work out a payment plan to get caught back up, or risk ruining your credit.

• Good credit, low interest – If you have good credit, you might have access to much lower interest rates than the IRS charges when you don’t pay your taxes. Also, even though the IRS offers a payment plan, they charge interest and penalties for each month you have an outstanding balance, so you may save money with a personal loan.

Is Using a Personal Loan to Pay Taxes a Bad Idea?

In some cases, using a personal loan to pay tax debt can be a good idea, but it depends on the situation.

• Interest and penalties – As we said, the IRS charges interest and penalties on all unpaid tax debt. If you don’t have excellent credit, you might not qualify for interest rates lower than the IRS charges. This means you’d pay more interest than what the IRS payment plan would cost. Plus, most banks charge an origination fee on personal loans, making them more expensive.

• Put your credit in danger – In addition, if you can’t make your monthly payments on the loan, you could ruin your credit and overall financial health. Even though personal loans don’t require collateral, the lender can send your account to collections or take legal action if you don’t make your payments.

Why Consider a Personal Loan to Pay Taxes

A personal loan may make sense if you qualify for a low interest rate and can afford the monthly payments or know you’ll have a sum of money to pay the loan in full. The interest charges may be lower, allowing you to pay the balance faster.

In addition, if you make your payments on time, you can increase your credit score with the loan, making having a tax balance work in your favor.

The Risks of Using a Loan to Pay Taxes

Just as there are good sides to using a loan to pay your tax debt, there are risks you should consider before you borrow money.

Higher Debt-to-Income Ratio (DTI)

You increase your DTI (debt-to-income ratio) when you borrow another loan. Your DTI compares your monthly income to your monthly debts. The lower it is, the easier it is to afford your monthly payments. It also looks better to lenders if you need a loan in the future. The more obligations you have, the harder it is to get approved for financing.

If you borrow a personal loan to pay your tax bill, be sure the payment doesn’t make your DTI exceed 43%, as that’s a common threshold for lenders.

Possibility of Higher Interest Rates

You may not get the best interest rates if you don’t have excellent credit. The IRS payment plan interest rate isn’t excessive, so a personal loan may cost more unless you have the credit scores to qualify for lower rates.

Alternatives to Paying Your Taxes via Personal Loan

If personal loans don’t feel right to pay your tax bill, there are a few other ways to tackle the debt.

• Payment plans with the IRS – An IRS payment plan can help you pay your tax debt, and there are two options. To decide which is right, determine your budget. Choose the short-term IRS repayment plan if you can pay the income taxes within six months. If not, you can choose the installment agreement but know it has fees and accrues interest.

• An installment plan – The IRS installment agreement is for people who owe taxes they can’t pay off within four months. To qualify, you must apply for an installment agreement and tell the IRS how much you can pay monthly. Then, if approved, you choose your payment date and pay the same amount each month.

  The installment agreement has a $130 setup fee without direct debit payments and $31 with direct debit payments. You’ll also pay penalties and interest monthly until you fully pay the debt. Typically, the IRS requires that you pay the debt in full within five years, so determine if you can afford the monthly payment that would allow that.

• A 6-month plan – However, don’t apply for the installment agreement if you owe taxes that you can pay within six months. Instead, complete the Online Payment Agreement. This agreement states you’ll pay the taxes off within six months. If you do, there isn’t a setup fee, but you will pay interest and penalties until you pay the balance in full.

• Pay with a credit card – If you already have a credit card with a low-interest rate and a high enough credit limit, consider using it to pay your taxes. This works great if you have a 0% APR credit card, but even one with a low APR works. If you already own a credit card, you don’t have to worry about qualifying, or if you have great credit, you may consider applying for a 0% APR card.

  The nice thing about paying with a credit card is you have a lower minimum payment. However, you should budget to pay the balance in full before your APR increases if you have an introductory APR or in as little time as possible if you’re paying interest.

• Borrow from your 401K or other retirement funds – If you have a hefty 401K balance, you might consider borrowing from it to pay your taxes. You don’t have to do much to qualify as long as your employer allows 401K loans. Most employees can borrow up to 50% of their balance or $50,000, whichever is less.

  However, there are some factors to consider.

  First, you must repay what you borrow, usually within five years with interest, and if you leave your job, you may owe the full payment immediately, or you risk paying penalties. Second, you are borrowing from your future. You can’t make up the compounded earnings you’ll lose, so choose this option cautiously.

• Use a payday loan – If the amount you owe is something you can pay off quickly, a payday loan can be a fast option. Payday loans are short-term loans that you repay on your next payday. However, the interest rates are high, usually around 400%, and if you can’t meet the repayment terms, you could end up in a vicious debt cycle.

  Only use a payday loan if you know you can repay the amount with your next check and not cause financial strain in other areas.

• Home equity – You might tap into your home if you have more than 20% equity and use the funds for paying taxes. Of course, it’s not the ideal use of your home equity, but since a home equity loan uses your home as collateral, you can usually get attractive terms.

  Only use this option if you can afford the payments and won’t default. Since your home is the collateral, you could lose your home if you miss too many payments.

  Use your savings or emergency fund – Using your savings or emergency fund isn’t ideal, but it avoids interest. If you can budget to fill your bank account again quickly with the funds used to pay the tax bill, consider it. Just make sure you’re diligent about saving the money again quickly, especially if you drain your emergency fund.

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Where You Can Find a Personal Loan to Pay Taxes

You can find a personal loan to pay taxes with an online personal loan lender or your local bank. Consider getting quotes from at least three lenders to compare your options. Look at the origination fees, closing costs, and interest rates charged.

Total the cost of the loan over its term and choose the loan that will cost the least, allowing you to take care of your unpaid balance on your tax bill.

Consequences of Not Paying Your Taxes

If you don’t pay your taxes, there are serious consequences. We never recommend not paying them. There are alternatives, and even IRS payment plans to help with your tax balance. Ignoring the tax bill isn’t worth the risk.

Here’s what could happen if you ignore your taxes.

1. If you don’t file your taxes, you’ll pay a failure to file penalty. The fee is equal to 5% of your taxes owed and is charged each month you don’t file your taxes. The penalty won’t be more than 25% of your tax bill.

2. If you don’t pay the full tax bill, interest accrues daily at the federal short-term rate plus three percent.

3. If you don’t pay your entire tax bill, you’ll pay a failure to pay penalty equal to half of a percent monthly, up to 25%. The penalty increases to 1% if the IRS sends a letter of intent to levy property for unpaid taxes. But, if you apply and are approved for an IRS payment plan, the interest rate decreases to a quarter of a percent.

FAQs

Using a personal loan to pay taxes may be viable for some people, so here are some frequently asked questions to learn more.

Is the Amount of a Personal Loan Guaranteed to Cover Your Tax Bill?

The loan amount you can secure with a personal loan depends on your qualifying factors. You can apply for the amount that will cover your tax bill, but there isn’t a guarantee lenders will lend as much as you need.

Are Personal Loans Consider Taxable Income?

Personal loans are not taxable income because you must repay the amount you receive plus interest. The only way it becomes taxable income is if the loan is forgiven for some reason, which is rare with personal loans.

Will a Personal Loan Affect the Tax Return You Receive?

A personal loan doesn’t affect future tax refunds if you’re eligible. However, if you still have a tax debt, the IRS will absorb your refund, applying it to the outstanding debt. You will receive the rest of the refund if there is a remaining balance.

What Else Can You Use a Personal Loan For?

There aren’t any rules on how you can use a personal loan. Just like you can use the funds for your tax debt, you can use it for any other purpose, such as consolidating debt, paying for a vacation, college tuition, or anything you want.

Is Interest Added to Your Tax Bill if You Do Not Pay Right Away?

Yes, accruing interest begins immediately after the tax due date if you don’t make the full payment by the tax due date. This applies even if you apply for an extension to file your taxes. The extension is to file your taxes, not pay your bill.

How Do You Determine a Good Personal Loan APR?

Personal loans usually start with an APR of around 6%, but that’s for people with outstanding credit. You’ll likely pay a higher APR if you have a credit score below 740. The key is to get quotes from multiple lenders to determine the best APR for your situation.

Personal Loan to Pay Taxes – The Bottom Line

If tax season stresses you out because you fear you won’t be able to pay your taxes by tax day, consider a personal loan to pay taxes as an option. Before you do, though, compare all options to satisfy your debt, including a payment plan from the IRS, a loan from family or friends, or a low-interest rate credit card.