A personal loan is generally an unsecured sum of money borrowed from a traditional bank, credit union, or an online lender. These loans come with fixed interest rates and repayment terms. Interest rates vary by lender and depending on the credit and financial health of the borrower.
There are virtually no restrictions on how personal loan funds can be used, so borrowers can use these loans to pay for whatever they want, including paying taxes. Before considering using a pre-tax loan, borrowers should consider what the best move is for their finances.
Should you take out a personal loan to pay your taxes?
If you’re strapped for cash and worried about how you’ll pay your taxes this year, it may be tempting to take out a personal loan to cover these costs.
Before choosing this option, consider the benefits and risks. Taking out a loan with interest and possible additional fees to pay expected annual expenses can 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 forms of financing. options.
Benefits of taking out a personal loan to pay your taxes
- Predictable monthly payments: A major advantage of personal loans is that they have fixed interest rates and repayment periods. Before you apply for the loan, you need to know exactly what you will pay in interest and when and for how long you have to pay. This predictability allows borrowers to plan ahead and ensures that they do not end up paying more in interest than they thought. Personal loan terms generally range from one to seven years.
- Low interest rates for borrowers with good credit: If you have favorable credit, you may qualify for an interest rate as low as 3 percent on personal loans. Although exact rates vary depending on the creditworthiness of the lender and the borrower, borrowers with strong credit generally will have no trouble finding a reasonable rate.
- Fast and easy application process: Personal loan providers tend to work quickly. The approval process usually takes place within a few days. The money reaches borrowers within 24 to 48 hours on average. While some lenders require you to 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 up collateral. This means that when you take out a personal loan, you do not run the risk of losing an asset, such as your house or car.
- Guarantee on tax returns: While taking on debt is always risky, taxpayers receive tax returns within 21 days of filing, ensuring that there is enough money available to pay off the loan. It may be smart to spend your tax refund on paying off this debt. The average tax refund so far in 2024 is just over $3,000.
Risks of taking out a personal loan to pay your taxes
- Potentially high interest: Borrowers with less favorable credit are unlikely to qualify for lenders’ minimum interest rates. These borrowers can pay up to 36 percent on average, depending on individual creditworthiness and financial health. The average interest rate on personal loans is currently 12.21 percent, meaning borrowers who have difficulty with credit are likely to receive even higher rates.
- Lender costs: Individual lenders have their own fees, including origination fees, late fees, application fees, etc. Pay particular attention to origination fees as they can range from 1 percent to 8 percent. Before applying for a personal loan, it’s important to know what costs you may be responsible for.
- Potential damage to credit score: Every time you take on debt, your credit score takes a hit. If you can make your loan payments on time over the life of the loan, you won’t have to worry about permanent damage to your credit score, and making these payments can even help build your credit score. However, if you can’t pay off your loan or have trouble making payments on time, your credit score will likely suffer.
- Can increase your debt-to-income ratio (DTI).: Your debt-to-income ratio is the amount of debt you have compared to your income. If you take out a new loan and your income remains the same, your DTI will increase. This could 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 should contact the IRS to discuss your options. If you simply ignore your taxes, the IRS will take money from your wages, federal benefits, and future tax refunds to cover the original amount plus penalties and interest.
The IRS provides different penalties for different violations, including failure to file a return, failure to pay in full, and dishonoring of checks. The IRS can also legally charge interest of at least 2 percent on a payment of $1,250 or more.
Alternatives to using a personal loan to pay taxes
If you can’t pay your taxes this year, consider the following options before deciding to take out a personal loan to cover the costs.
Payment plan from the tax authorities
The IRS does offer payment plans to taxpayers who cannot pay their taxes all at once. Individuals can choose from a long-term payment plan or a short-term payment plan of 120 days.
Full payment within 120 days
For those who just need a little extra time to pay their taxes, this six-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 pay off your tax debt in full. If you can pay early and pay off the debt within 120 days, it’s a good idea to do so.
Payment plan
You can also request an IRS repayment agreement if you need more time to pay off the debt. This plan involves telling the IRS how much you can pay per month, and they can approve or deny your request. You then make the agreed payments over a certain period of time. This option incurs a $225 origination fee, on top of accrued interest and penalties. However, if you are a low-income taxpayer, you may be able to get these fees waived.
Credit card
Another option for those who struggle to pay their taxes is to pay 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 can be an affordable option. However, you are responsible for processing fees, although these fees may be tax deductible.
If you do qualify for introductory financing without interest, it is wise to pay off your debt as much as possible before you have to pay interest.
Using a credit card to pay your taxes is typically a more flexible option than IRS payment plans or personal loans, due to the lower monthly minimum payments on average. However, interest rates on credit cards can be much higher, especially if you don’t have favorable credit.
401(k) loan
If you have a 401(k) loan, you can 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 and have to pay interest on a 401(k) loan. Borrowers can withdraw up to 50 percent of their account balance or $50,000, whichever is less. You normally have up to five years to pay off these loans.
These loans do come with risks, including paying taxes and penalties on the loan if you don’t pay it back on time. These loans are also contingent on employment, meaning that if you leave your job before fully repaying the loan, you no longer have five years to pay it back. Under these circumstances, the borrower has time until his previous employer files a tax return the following year to pay off his loan without having to pay penalties or default on the loan.
In short
For those who are 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 that you will soon have the money to pay off the loan, personal loans are a quick and easy way to get money at low interest rates for good to excellent borrowers.
However, dealing with interest and additional lender fees increases 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 harm your overall financial health.
If possible, plan ahead for tax season to avoid this additional financial stress. If you’re 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’re self-employed. If that’s not enough, you can also consider opening a savings account specifically for taxes and depositing money into it throughout the year.
If you decide to take out a personal loan to pay your taxes, make sure you get the best rates by comparing lender details before applying.
