A personal loan is usually an unsecured sum of money borrowed from a traditional bank, credit union, or online lender. These loans come with fixed interest rates and repayment terms. Interest rates vary by lender and by the credit and financial health of the borrower.

There are virtually no limitations on how money from personal loans can be used, so borrowers can use these loans to pay whatever they want, including paying taxes. Before considering using a tax loan, borrowers should think about the best solution 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, taking out a personal loan to cover that expense might be tempting.

Before committing to this option, consider the benefits and risks. Taking out a loan with interest and potential additional fees to pay for a planned annual expense could put you more in debt, but personal loans offer fixed interest rates and repayment plans that can sometimes be cheaper and more consistent than personal loans. IRS payment plans and other financing. options.

Advantages of taking out a personal loan to pay your taxes

  • Predictable monthly payments: One of the main advantages of personal loans is that they come with fixed interest rates and repayment periods. You need to know exactly what you will pay in interest and when and for how long you will have to make payments before signing up for the loan. This predictability allows borrowers to plan ahead and ensure that they don’t end up paying more than they thought in interest. The terms of personal loans generally vary from 1 to 7 years.
  • Low interest rates for borrowers with good credit: If you have good credit, you can qualify for interest rates as low as 3% on personal loans. Although exact rates vary depending on the creditworthiness of the lender and borrower, borrowers with strong credit generally won’t have trouble finding a reasonable rate.
  • Quick and easy application process: Personal lenders tend to work quickly. The approval process usually takes place within a few days. Funds reach borrowers in an average of 24-48 hours. 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 post collateral. This means that you do not risk losing an asset like your house or your car by taking out a personal loan.
  • Income Tax Return Guarantee: While going into debt is always risky, taxpayers receive their tax returns within 21 days of filing, ensuring funds are available to help repay the loan. It may be a good idea to use your tax refund to pay off this debt. The average tax refund so far in 2022 is $2,323.

The risks of taking out a personal loan to pay your taxes

  • Potentially high interest rates: Borrowers with less favorable credit are unlikely to qualify for minimum lender interest rates. These borrowers could pay up to an average maximum of 36% depending on their creditworthiness and financial health. The average personal loan interest rate is currently 30 percentwhich means borrowers who have difficulty with credit are likely to receive even higher rates.
  • Lender fees: Individual lenders have their own fees which may include origination fees, late fees, application fees, etc. Pay attention to the assembly fees in particular, as they can vary from 1% to 8%. It’s important to know what fees you may be responsible for before applying for a personal loan.
  • Potential damage to credit rating: Every time you incur debt, your credit score takes a hit. If you’re 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 those payments might even help boost your score. credit. However, if you’re unable to repay your loan or have trouble making your 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 your debt compared to your income. When you take out a new loan and your income remains the same, your DTI increases. This may 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 imposes different penalties for different infractions, including failure to deposit, failure to pay in full, and dishonored checks. The IRS can also legally charge a minimum interest of 2% 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 expenses.

IRS Payment Plan

The IRS offers payment plans for taxpayers who are unable to pay their taxes all at once. Individuals can choose between a long-term payment 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 might be a solution. The IRS does not charge any fees for this plan, but interest and penalties will continue to accrue until you fully repay your tax debt. If you are able to make prepayments and finish paying off the debt before the 120 days are up, it’s a good idea to do so.

Installment plan

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, when they can approve or deny your request. You then make the agreed payments over a fixed term. This option involves a setup fee of $225 plus accrued interest and penalties. However, if you are a low-income taxpayer, you may be able to obtain a waiver of these fees.

Credit card

Another option for those struggling to pay their taxes is to pay your taxes with a credit card. If you qualify for a credit card with interest-free financing and a high enough credit limit to pay what you owe, this could be an affordable option. You will, however, be responsible for the processing fees, although these fees may be tax deductible.

If you qualify for interest-free upfront financing, it’s wise to pay off as much of your debt as possible before you 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 minimum monthly payments on average. However, interest rates on credit cards can be much higher, especially if you don’t have good credit.

401(k) loan

If you have a 401(k), you can take out a 401(k) loan from your retirement fund. With this type of loan, you borrow money from yourself in order to pay yourself back. However, you are still retired to pay interest on a 401(k) loan. Borrowers can withdraw up to 50% of their account balance or $50,000, whichever is less. You usually have up to five years to repay 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, i.e. if you quit your job before repaying the loan in full, you no longer have five years to repay it. In these circumstances, the borrower has until their previous employer files their taxes the following year to repay their loan without incurring penalties or defaulting on the loan.

At the end of the line

For those struggling to find money for taxes this year, taking out a personal loan is a potentially attractive option. If you have good credit and are confident that you will soon have the money to repay the loan, personal loans are a quick and easy way to get cash with low interest rates for good-to-goodness borrowers. great credit.

However, interest and additional lender fees increase the cost of your loan, and your credit could be damaged if you have trouble repaying the loan. In some cases, taking out a personal loan to pay taxes could harm your overall financial health.

If possible, plan ahead for tax season to avoid this added financial stress. If you’re having trouble paying taxes this year, consider asking your employer to adjust your W-4 deductions for next year or adjust your estimated quarterly 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.