Should You Use a Personal Loan to Pay Taxes?


An expensive tax bill can cause a lot of financial stress, especially if it’s unexpected.

If you don’t have enough savings, a personal loan may seem like a good way to settle the bill, but you likely have cheaper options.

Here’s what to know about using a personal loan to pay taxes and alternatives to consider.

Can you use a personal loan to pay taxes?

There are few restrictions on how you can use the funds from a personal loan, so you technically can use one to pay your taxes. Some lenders prohibit using a personal loan for certain expenses, like higher education costs or investments, but taxes generally aren’t among them.

Your tax bill amount could stand in your way if it’s too small. Personal loan amounts typically start around $1,000, so you may have a hard time finding a loan if you owe a few hundred dollars.

A personal loan may seem appealing because it can make a large tax bill more manageable by spreading the cost over time, but because interest rates can be high — some lenders charge annual percentage rates up to 36% — it’s worth your time to consider other options before using a personal loan to pay taxes.

Pros and cons of using a personal loan to pay taxes

Cons


Missed loan payments can damage your credit.

Pros of using a personal loan to pay taxes

Quick funding: Funding times vary, but most lenders can fund a personal loan within a week. Some lenders can fund a loan the same day you’re approved.

Avoid IRS penalties: You’ll avoid paying IRS penalties, which can add up.

Fixed monthly payments: Personal loans are fixed-rate installment loans. This means you’ll have consistent monthly payments throughout your loan term, which is usually two to seven years. Having the same payment each month makes it easy to budget for.

Cons of using a personal loan to pay taxes

APRs can be high: Personal loan interest rates can be high, especially for consumers with poor credit scores (below 630) or thin credit histories.

Possible fees: Some lenders charge origination fees to cover the cost of processing a loan. Origination fees typically range from 1% to 10% of the total loan amount, and many lenders deduct the cost from the loan proceeds, leaving you with a smaller amount.

Missed loan payments can damage your credit: Unlike being late on your taxes, which initially has no impact on your credit, a late or missed personal loan payment could cause your credit score to drop significantly.

Higher DTI: A personal loan increases the amount of debt you have, which means your debt-to-income ratio will rise. If you plan to get another form of financing in the future — like a mortgage or auto loan — a high DTI may prevent you from qualifying.

What happens if you can’t pay your tax bill

If you don’t pay your taxes by the deadline, the IRS charges you interest and penalty fees.

Interest: The IRS charges interest on the unpaid tax bill, equal to the federal short-term rate plus 3%. The interest rate can change each quarter but has most recently ranged from 6% to 8%.

If you file but pay late: The failure-to-pay penalty is initially 0.5% of the unpaid amount per month, with a maximum of 25%.

If you don’t file: If you owe taxes but don’t file your return at all, you’ll be charged 5% of the amount owed monthly, up to a maximum of 25% of the unpaid amount. Those who are over 60 days late could owe a minimum of $485.

If you don’t pay for a prolonged period, the IRS can resort to more severe actions, including wage garnishment, bank account seizure and tax liens against your property.

Alternatives to using a personal loan to pay taxes

A personal loan isn’t the only solution if you have a tax bill you can’t afford to pay. Here are several alternatives.

IRS payment plan

An IRS payment plan is a deal you make with the IRS to pay your tax bill over time. There are short-term IRS payment plans for taxpayers who owe less than $100,000 and can pay the balance in 180 days. There are also long-term payment plans for those who owe less than $50,000 but need more than 180 days to settle the bill.

Zero-interest credit card

A zero-interest credit card may be an affordable way to pay an expensive tax bill over several months, as long as you pay the balance before the card’s zero-interest promotional period ends — typically the first 15 to 21 months.

401(k) loan

If you have a retirement account through your employer, you could consider getting a 401(k) loan to cover the tax bill. You can typically borrow up to half of your account balance or $50,000, whichever is less, for up to five years.

Home equity loan or line of credit

A home equity loan and a home equity line of credit (HELOC) are both types of secured financing where you use your home as collateral.

A home equity loan is a type of installment loan where you get a lump sum of money at a fixed interest rate and monthly payments are consistent throughout the length of your loan term.

A HELOC is a type of revolving credit you can continuously draw upon until you reach your credit limit. Interest rates and monthly payments are usually variable.

Family loan

If you have a trusted family member who can afford to help you out, consider asking for a family loan. This borrowing method may feel informal and it can be awkward to ask loved ones for money, but this can be a quick, low-cost way to get the funds you need to cover a tax bill.



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