A personal loan is generally an unsecured sum of money borrowed from either a traditional bank, credit union or an online lender. These loans come with fixed interest rates and repayment terms. Interest rates vary by lenders and by the borrower’s credit and financial health.
There are virtually no limitations on how personal loan money can be used, so borrowers can use these loans to pay for whatever they want, including paying taxes. Before considering using a loan for taxes, borrowers should consider what the best move for their finances is.
Should you take out a personal loan to pay your taxes?
If you are strapped for cash and worried about how you will pay your taxes this year, taking out a personal loan to cover this expense could be tempting.
Before committing to this option, consider the benefits and risks. Taking out a loan with interest and potentially added fees to pay for an expected yearly expense could leave you deeper in debt, but personal loans do offer fixed interest rates and repayment plans that can sometimes be cheaper and more consistent than IRS payment plans and other financing options.
Benefits of taking out a personal loan to pay your taxes
Predictable monthly payments: One major perk of personal loans is that they come with fixed interest rates and repayment periods. You should know exactly what you will pay in interest and when and for how long you will be expected to make payments before you sign on for the loan. This predictability lets borrowers plan ahead and ensures they don’t end up paying more than they think they would be in interest. Personal loan terms generally range from one to 7 years.
Low interest rates for borrowers with good credit: If you have favorable credit, you may qualify for interest rates as low as 3 percent on personal loans. While exact rates vary by lender and borrower’s creditworthiness, borrowers with strong credit will generally not have trouble finding a reasonable rate.
Quick and simple application process: Personal loan lenders tend to work fast. The approval process generally happens within a few days. Funds get to borrowers within 24 to 48 hours on average. While some lenders require that you close in person, many allow you to complete the process entirely online.
No collateral required: Unlike a home equity loan or other types of secured loans, personal loans do not require borrowers to put down collateral. This means that you will not be at risk of losing an asset like your home or car from taking out a personal loan.
Guarantee of tax returns: While taking on debt is always risky, taxpayers receive tax returns within 21 days of filing, guaranteeing some funds available to help pay off the loan. It may be smart to put your tax refund toward paying off this debt. The average tax refund so far in 2022 is $2,323.
Risks of taking out a personal loan to pay your taxes
Potentially high interest rates: Borrowers with less favorable credit likely will not qualify for lenders’ minimum interest rates. These borrowers could pay up to an average maximum of 36 percent depending on individual creditworthiness and financial health. The average personal loan interest rate is currently 10.71 percent, meaning borrowers who struggle with credit are likely to receive even higher rates.
Lender fees: Individual lenders have their own fees which can include origination fees, late fees, application fees, etc. Look out for origination fees in particular, as these can range from 1% to 8%. It is important to know what fees applying you could be responsible for before for a personal loan.
Potential damage to credit scores: Any time you take on debt, your credit score takes a hit. If you are able to make your loan payments on time throughout the life of the loan, you don’t have to worry about permanent damage to your credit score, and making these payments could even help build up your credit score. However, if you are unable to pay off your loan, or are having trouble making payments on time, your credit score will likely suffer.
Could increase your debt to income ratio (DTI): Your debt to income ratio is the amount of debt you have versus your income. When you take out a new loan and your income stays the same, your DTI increases. This can negatively impact your ability to qualify for future loans or mortgages.
What happens if you can’t pay your taxes?
If you are unable to pay your taxes, you must contact the IRS to discuss your options. Simply ignoring your taxes will result in the IRS taking money from your wages, federal benefits and future tax refunds to cover the original amount plus penalties and interest.
The IRS issues different penalties for different offenses, including failure to file, failure to pay in full, and dishonored checks. The IRS can also legally charge a minimum 2 percent interest on a payment of $1,250 or more.
Alternatives to using a personal loan to pay taxes
If you are unable to pay your taxes this year, consider the following options before deciding to take out a personal loan to cover the expense.
IRS payment plans
The IRS does offer payment plans to taxpayers who are unable to pay their taxes all at once. Individuals can choose from a long-term installment plan or a short-term, 120-day payment plan.
Full payment within 120 days
For those who just need a little extra time to pay their taxes, this 6-month payment plan could be a solution. The IRS does not charge any fees for this plan, but interest and penalties will continue to accrue until you fully pay off your tax debt. If you are able to make payments early and finish paying off the debt before the end of 120 days, this is a good idea to do so.
You can also apply for an IRS installment agreement if you need more time to pay off the debt. This plan involves telling the IRS how much you are able to pay per month, at which point they can approve or deny your request. You then make the agreed-upon payments over a set amount of time. This option involves a setup fee of $225 on top of accruing interest and penalties. However, if you are a low-income taxpayer, you may be able to get this fee waived.
Another option for those struggling to pay their taxes is paying your taxes with a credit card. If you qualify for a credit card with no-interest financing and a credit limit high enough to pay what you owe, this could be an affordable option. You will, however, be responsible for the processing fee, although this fee may be tax deductible.
If you do qualify for introductory no-interest financing, it is wise to pay off as much of your debt as possible before you have to start paying interest.
Using a credit card to pay your taxes tends to be a more flexible option than IRS payment plans or personal loans, due to lower monthly minimum payments on average. However, interest rates on credit cards can be much higher, especially if you do not have favorable credit.
If you have a 401(k), you could take out a 401(k) loan from your retirement fund. With this type of loan, you borrow money from yourself with the intention of paying yourself back. However, you are still retired to pay interest on a 401(k) loan. Borrowers can take out up to 50 percent of their account balance or $50,000, which ever is less. You generally have up to five years to pay off these loans.
These loans come with risks, including paying taxes and penalties on the loan if you don’t repay it on time. These loans are also dependent on your employment, meaning that if you leave your job before repaying the loan in full, you will no longer have five years to repay it. Under these circumstances, the borrower has until their previous employer files taxes the next year to pay off their loan without incurring penalties or defaulting on the loan.
For those struggling to find the money for taxes this year, taking out a personal loan is a potentially good option. If you have good credit and are confident you will soon have the money to pay off the loan, personal loans are a quick and simple way to get cash with low interest rates for good to excellent credit borrowers.
However, dealing with interest and added lender fees add to the cost of your loan, and your credit could be damaged if you have trouble paying off the loan. In some cases, taking out a personal loan to pay taxes can hurt your overall financial health.
If possible, plan ahead for tax season to avoid this added financial stress. If you are having trouble paying taxes this year, consider asking your employer to adjust your W-4 withholdings for next year or adjust your quarterly estimated taxes if you are self-employed. If that isn’t enough, you could also consider opening a savings account specifically for taxes and depositing money into it throughout the year.
If you do decide to take out a personal loan to pay your taxes, make sure you are getting the best rates by comparing lender details before applying.