When Should You Use a Personal Loan to Pay Taxes?

What is a tax loan?

Starting with the basics, a tax loan is simply a personal loan that is used to pay off the tax bill you owe to the IRS. This personal loan may be secured or unsecured. Once receiving the sum of the personal loan requested, a borrower can pay their taxes to the IRS and begin their repayments to the lender who gave them the loan.

How does a tax loan work?

The concept of a loan to pay taxes can be confusing on the surface but is made clearer when broken down. When a borrower requests a personal loan from a lender, they will be required to request a certain amount. In the situation of using loans to pay taxes, the amount requested would be equal to what you owe in taxes.

After going through a loan application and approval process, a lender would provide you with the total amount you request minus any potential fees outlined during the contract formation process. This personal loan for tax debt can then be used to pay the IRS immediately.

Once you receive the funds from the lender, you will be responsible for monthly repayments on that loan. Most personal loans have term lengths ranging from two years to seven years, meaning you will be making those monthly payments for that amount of time. Interest will also be included within these monthly payments, with the rate being agreed upon at the time of contractual signing.

What happens if you can’t pay your taxes?

Finding out you can’t pay your taxes is no enjoyable experience. With that said, you should still file your return and pay as much as you are able to by the tax payment due date. It’s possible that you may qualify for a self-service, online payment plan allowing you to pay your taxes overtime.

However, the IRS defines two primary payment plans: short-term and long-term. To qualify for the former, the payment period must be 120 days or less and the total amount owed must be under $100,000 including all taxes, penalties, and interest. To qualify for the long-term plan, the payment period must be longer than 120 days, with amounts paid monthly, and the total owed must be less than $50,000. If you don’t fit into either category, finding a lender to borrow money to pay taxes can potentially be beneficial.

When should you get a personal loan to pay taxes?

Personal loans can come with high interest rates, fees, and other factors that, for some people, may not make it the ideal repayment strategy for taxes. However, using a loan to pay back taxes could be right for you if you are currently faced with a tax bill that you can’t afford to pay now or in the coming future.

Additionally, if the fees, interest, and other costs of setting up an IRS payment plan are beyond the costs of interest or fees with a personal loan, the latter can be the better choice. Finally, those of you with good to excellent credit scores will likely receive more favorable interest rates on loans, which can make it a safer option.

Read more: Are personal loans taxable

Pros of using a personal loan to pay taxes

As with all purposes of a loan, there are both pros and cons to be aware of. Here are some of the key benefits from using a loan for taxes owed:

• Most personal loans are unsecure and don’t require any form of collateral.
• Interest rates may be favorable with a good to excellent credit score.
• Reasonable and flexible contract terms.
• Can potentially be cheaper than an IRS installment plan, depending upon individual factors.

Cons of using a personal loan to pay taxes

While the above benefits can make taking out a personal loan to pay tax bills tempting, consider the following drawbacks before making any decisions:

• With a lower credit score, the interest rate offered may be too high to make this strategy worth it.
• Depending on the amount you owe in taxes, a personal loan may not cover all of what you need.
• Defaulting on a personal loan will heavily impact your credit score negatively.
• Adding long-term debt when already unable to meet tax payments may indicate an inability to handle debt.

Taking on a loan is a serious decision that requires a person to look at all the positive and negative factors that may occur.

Where can I get a personal loan to pay taxes?

Assuming you have decided that a personal loan to pay taxes is the right decision for you, there are several lenders you can turn to for funds. The three most common types of lenders for personal loans are banks, credit unions, and online third-party lenders. When considering your loan options, don’t be afraid to shop around and see who can offer you the best rate on a personal loan.

Compare: Best Personal Loans

Alternative options for meeting tax payments

Using a loan to pay off taxes isn’t the right strategy for everybody. If this is the case for you, consider some of the following alternatives that will likely be similar in cost:

1. IRS payment plans

If you qualify for one of the IRS payment plan categories and the all-in total cost of this plan is less than a personal loan, it is the better option. Be aware, though, that a failure to follow this payment plan may potentially put some of your assets at risk of possession by the IRS.

2. Credit cards

Should the total amount you owe in taxes fall within your credit limit, using a credit card to make the payment can be a viable strategy. However, this can be an expensive way of financing your tax bill if your APR is high and the amount of taxes you paid is also high. This strategy is only best if you can quickly pay off the tax bill before large amounts of interest begin to accrue on your credit card.

3. Family or friends

If you have family or friends who are willing to help you out with your tax payments, consider reaching out for support. This can be an excellent strategy as the potential for losing personal assets is heavily reduced but be sure to pay your loved ones or friends back to avoid placing a strain on any relationships.

4. Payday Loans

Payday loans are an extremely slippery slope that can often lead to a major cycle of debt if you are unable to quickly meet your loan payment. This type of loan often comes with an extremely high APR, reaching 400% in some cases, and the repayment window is typically very quick. Most lenders will require repayment by the next payday from your job, or interest will begin to accrue. This option is only viable for people who have the funds to pay their taxes, but it’s just not in their bank account at the tax due date.

Avoid taking on a payday loan if you will be unable to meet the complete repayment by your next payday.

5. Lines of Equity or Credit

A line of equity or line of credit gives you access to an amount that you can borrow, repay, and borrow again up to a certain dollar value. Similar to credit cards, a minimum monthly payment must be made on any amount currently outstanding. A line of equity uses the value of your home as collateral on a line of credit.

6. A 401(k) Loan

401(K) loans allow a person to borrow an amount of money against the money in their 401(K) accounts. Be aware, though, that you can’t borrow more than what you have in your 401(K), and in the event, you can’t meet your payments, you will lose your retirement funds.

IRS payment plans vs. personal loans vs. credit cards

When trying to choose between the many different tax repayment strategies, remember to consider all the factors. Interest rates, payment terms, repayment period, total APR, and more are all crucial to look at when evaluating your options. A personal loan for taxes might be the cheapest option for some, but not others. Always evaluate your own personal financial situation before making the decision to take on any form of debt.

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