Some people use a personal loan to pay taxes and avoid federal interest and other tax-related fees. Depending on factors like the amount owed and credit score, a personal loan could end up costing less than other options for settling tax debt. With that in mind, here’s everything you need to know about using a personal loan to pay off tax debt, including the pros and cons of doing so.
How to Get a Personal Loan to Pay Off Tax Bills
The process to apply for an available personal loan is pretty straightforward. Most personal loans are considered unsecured loans. They often come in a lump sum, have a fixed interest rate, and must be repaid in monthly installments. They’re also often easy to obtain and can be used for nearly anything, including paying tax debt.
Here’s how to go about it:
- Determine the borrowing amount: Only borrow what’s needed to pay off the tax debt. Borrowing too much could result in unmanageable debt or high monthly bills.
- Check your credit score: It’s possible to get a personal loan with fair or poor credit, but borrowers with good credit (670+ FICO) usually qualify for the best rates. Checking one’s credit score before applying can help determine their eligibility. For those with poor credit, consider going with a secured loan instead.
- Compare lenders: Shop around to see what different lenders offer in terms of loan amounts, interest rates, any additional fees, and loan terms.
- Determine eligibility requirements: Check the lender’s eligibility requirements, such as a minimum credit score or maximum DTI ratio, before applying.
- Check for incentives: Some lenders offer an autopay discount with automatic withdrawals or flexible repayment plans.
- Read online reviews: Check online for personal loan providers reviews to see what customers are saying. The Better Business Bureau (BBB) is a good place to start.
- Get prequalified: Prequalification lets the borrower see what they might qualify for without impacting their credit score. It usually requires the borrower’s full name, basic contact and income information, date of birth, and Social Security number.
- Apply: After finding the best lender, complete the online application. This step usually results in a hard inquiry, which can remain on the credit report for up to 2 years. Applicants may also need to provide additional information, such as proof of income.
- Wait for approval: Some lenders offer same-day approval, while others take several business days.
- Make payments on time: Most lenders require the first payment within 30 days of receiving the funds. Make the payments on time to avoid any late penalties or hurting your credit.
Pros and Cons of Using a Personal Loan to Pay Tax Debt
A personal loan is an option for paying off tax debt, but it’s not always the best one. Before applying for a personal loan, consider the following advantages and disadvantages.
- Most personal loans have a fixed interest rate, which lets the borrower know how much they’ll need to pay each month in advance.
- Applicants usually receive funds within 1 to 7 business days.
- The application process is usually quick, easy, and online.
- Borrowers with good or excellent credit could receive a lower interest rate and more favorable terms. This may make personal loans less expensive than other options like an IRS payment plan or a credit card.
- Certain banks and credit unions offer better interest rates or terms to borrowers who already bank with them.
- Those with poor credit may still qualify if they apply with a cosigner.
- Making on-time payments could improve one’s credit score.
- If the initial application requires a hard inquiry, it could cause a temporary dip in one’s credit score.
- Late or missed payments could result in late fees or damage one’s credit.
- Borrowers with poor credit may receive high-interest rates, which could make the personal loan more expensive than other payment options.
- Those with a high debt-to-income ratio or unstable income may be unable to qualify on their own.
- If the owed amount in taxes is lower than the lender’s minimum borrowing amount, one could end up borrowing more than what they need. This could result in a higher debt burden than anticipated.
- Personal loans may come with additional fees, such as an application fee, prepayment fees, late fees, or an origination fee.
- Getting a loan may increase the borrower’s overall debt-to-income ratio, making it more difficult to qualify for other lines of credit or loans.
What Happens If One Cannot Pay Their taxes?
If one does not pay their taxes by the final date for filing a tax return (which is on or around April 15th each year) they may start receiving debt collection notices in the mail, followed by phone calls. Although it may be possible to file for an extension, the person filing will still typically need to pay their tax debt by the April deadline. If the debt remains unpaid, they may receive a federal tax liens against their property or other assets.
There are several other consequences of not paying taxes, including the following penalties:
- Failure to file: This monthly penalty is for those who don’t file a tax return on time. It is for 0.5% of the unpaid amount starting from the month after the initial due date.
- Dishonored payment: If a check or other payment method doesn’t clear, there is typically a 0.2% penalty on the written amount.
- Failure to pay: The IRS usually charges 0.5% of the total unpaid tax debt that carries over from one month to the next. This penalty caps out at 25% of the total amount owed. Those who file on time and set up an approved payment plan with the IRS may get this penalty lowered to 0.25% each month. Anyone who qualifies for an automatic two-month extension may be able to temporarily avoid this late penalty. However, they will still be subject to interest charges.
- Interest: Unpaid taxes also accrue interest that compounds daily starting from the day after taxes are due until they’re paid in full. The exact percentage is determined quarterly and is currently 3.00% plus the federal short-term interest rate of 0.81%.
The interest and other penalties are based on how long the taxes have been due, as well as the amount owed. Because of this, it’s usually a good idea to make at least a partial payment to lower the total charges.
Also, it may be possible to remove or reduce late payment penalties by filling out a form with the IRS. To do this, be prepared to provide a reasonable cause as to why the taxes were not paid. Commonly accepted reasons include:
- Natural disaster
- Death in the immediate family
- An inability to get the records needed to file
For those who still need help paying their taxes, contact the IRS for more information. A representative might be able to help by suggesting or setting up an appropriate repayment plan. For best results, and to avoid additional fees, contact them before the taxes are due.
Alternative Options for Paying Taxes
If using a personal loan to pay taxes isn’t the right call, the IRS also offers the following payment plans:
- Short-term payment plans: This option grants the individual up to 180 additional days to pay their tax debt. It’s free to set up, but it does come with penalties and interest that accrue until the debt is fully repaid.
- Installment agreements: For those who need more time, there are long-term payment plans available, such as the direct debit installment agreement and the payroll deduction installment agreement. These require regular monthly payments and come with applicable interest and penalties. Some also cost a nominal fee to set up, depending on the individual’s income and plan type.
- Offer in compromise (OIC): Individuals with a qualifying financial hardship may qualify for an OIC. This is an agreement that lets them pay less than what they originally owed. When applying for one, the IRS considers various factors, including their income, expenses, assets, and ability to pay.
- Temporarily delayed collection: Those who can’t pay their taxes due to a specific financial hardship may be eligible for a temporary delay in collecting the taxes. The individual will still be responsible for any late penalties and compounding interest that accrues.
Contact the IRS to discuss tax payment plan options and for more information on each one. Outside of the IRS’ payment plans, here are some other options for paying taxes:
- Savings account: Typically offered by banks, credit unions, and online lenders, savings accounts are a secure way to store money while gaining a small amount of interest each month. If possible, plan ahead for next year’s taxes by setting aside some money in a savings account specifically for them. Even if it’s not enough to cover the full amount, it can help reduce the amount owed and prevent any late penalties.
- Home Equity Line of Credit: A home equity line of credit (HELOC) or a home equity loan can be used to pay taxes at a better interest rate compared to the IRS payment plans. Both methods do use one’s home as collateral, though, so defaulting on it could put the property in jeopardy.
- Credit cards: Although many credit cards have high interest rates, some come with a low or 0% introductory APR that usually lasts 12 to 18 months. As long as the individual can pay the balance in full during this introductory period, they can avoid any additional late penalties or high interest rates from the IRS.
Should you pay your taxes with a personal loan?
For some people, a personal loan may be the best option to pay their taxes, especially if they’re trying to avoid penalties or higher interest rates with the IRS. It’s also possible to improve your credit score with a personal loan over time and with good money management habits.
However, personal loans aren’t for everyone. That’s why there are other ways to pay taxes, such as with a low-interest credit card or an IRS payment plan. If you need more guidance on tax relief, or if you want to be prepared for the next tax season, try to plan ahead. That way, you can avoid a scenario in which you owe taxes in the future.