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How to use a personal loan to pay your tax bill

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If you have a federal tax bill you can’t afford to pay, a personal loan is one way to settle that debt and avoid IRS penalty fees and interest.

Taking out a personal loan, which is an unsecured, lump-sum loan that is repaid monthly at a fixed interest rate, may cost you less than other tax payment options and can be obtained quickly and easily if you qualify.

Pros and cons of using a personal loan to pay taxes

A personal loan is not a good payment solution for everyone who owes taxes. It depends on whether a personal loan will cost less than other options. So, how much you owe and how long it will take you to pay the balance are major considerations.

Here’s a look at the pros and cons of using a personal loan to pay taxes.

Pros

  • A personal loan is generally easier to qualify for than a home equity loan. Credit score requirements, for example, may be lower.
  • A personal loan usually does not require the borrower to put up collateral to secure the loan.
  • A personal loan usually has a fixed interest rate, so your payments stay the same for the term of the loan.
  • The most qualified borrowers can get rates of around 5 to 6 percent, which is cheaper than a credit card and comparable to home equity rates, but without having to risk your home as collateral.
  • Loan funds can be obtained very quickly if you qualify. Many personal loan lenders are online, making the application and approval process faster. As a result, lenders can disburse loan funds rapidly – in some cases, the same day.
  • Banks and credit unions may offer special interest rate discounts if you’re already a customer.
  • Online lenders don’t have brick-and-mortar locations, so they may pass on the savings to you via lower interest rates.

Cons

  • A personal loan may not be the best solution for taxpayers who owe less than $1,000. Many lenders won’t grant a personal loan for less than $1,000; some have even higher minimums of $2,000 to $5,000. If your tax bill is less than what you’d have to borrow, explore other payment alternatives.
  • Some lenders impose restrictions on how you can use a personal loan.  Before applying, confirm that the lender will let you use the money to pay a tax bill.
  • If your credit isn’t good, you may not be eligible for an unsecured personal loan because they typically are reserved for people with higher credit scores.
  • Personal loan interest rates are higher, on average, than home equity rates. The average personal loan rate is 10.38 percent, according to Bankrate’s latest weekly rates survey. Home equity lines of credit average 6.79 percent; $30,000 home equity loans, 5.95 percent.

What happens if you can’t pay your taxes

Your 2021 tax return is due to the IRS by April 15, 2022. If you owe taxes and fail to pay by the due date, the IRS immediately starts charging you interest and penalties.

The interest rate charged to delinquent taxpayers is three percent annually.

The monthly penalty for late payment is half of 1 percent of the amount owed, up to 25%. The failure-to-file penalty is 5 percent of the amount due for every month the payment is late, up to 25 percent. If both penalties are applicable in a month, the combined penalty is 5 percent.

For example, if you owe the IRS $10,000 and you do not file a tax return, you will owe $525 a month in interest and penalties alone. Here is how it breaks down:

  • 3 percent interest annually, which is $300, or $25 per month.
  • 5 percent penalty for failure to file and failure to pay, which is $500 monthly.

As you pay down your tax bill, the amount you pay monthly in penalties and interest is reduced. The failure-to-file penalty ends after five months, but the penalty for nonpayment continues until the tax is paid, up to 25 percent.

If you file on time and ask the IRS for an installment agreement, the nonpayment penalty is reduced to 0.25 percent.

“It’s really not the government gouging people. It’s the government making sure people don’t procrastinate and are motivated to pay their taxes,” says Francine Lipman, a law professor specializing in tax law at the William S. Boyd School of Law at the University of Nevada, Las Vegas. “It is both carrot and stick.”

If you cannot pay all or part of your tax bill by the due date, you should still file your return on time and pay as much as you can. You should also contact the IRS at (800) 829-1040 to talk about payment options.

Alternative payment options

The IRS knows it can be hard to come up with the cash if you owe at tax time, so it offers options:

  • Short-term payment plan: The IRS gives you 180 days to pay up.
  • Full payment agreement: Under this plan, you may qualify for an additional 120 days to pay your tax bill. Interest and penalties continue to accrue until you pay your balance in full, but there is no extra fee to set up the plan.
  • Long-term payment plan: The IRS may agree to a monthly payment plan, including direct debit from your bank account, monthly payment made online or over the phone via Electronic Federal Tax Payment System (EFTPS), payment via check, money order or debit/credit card. Fees to set up a long-term payment plan range up to $225.

If you can’t pay your tax bill and you’re not approved for an installment agreement, a personal loan could be a good option for you.

“The interest rate is ridiculously low with the IRS,” says CPA Kristin Ingram, head of Ingram Digital Media, which teaches small-business owners and college students about bookkeeping and accounting. “But if you think it will take you a while to pay this off, then a personal loan might be a better option because the penalty can get very high.”

Let’s calculate the cost of a personal loan for the $10,000 tax bill cited above. If you have good credit and qualify for a $10,000 loan at 5.99 percent over three years, your monthly payment would be about $314. In three years, you would pay about $950 in interest. The IRS penalties alone on a $10,000 tax bill could easily exceed $950.

The IRS will allow you to pay your tax bill with a credit card, but it will charge a processing fee of up to 1.99 percent of the balance. Plus, you’ll need to consider credit card interest rates, which average 16.31 percent, Bankrate’s latest survey shows. Clearly, a credit card with a double-digit interest rate is not the best way to pay off a tax bill.

Consider using a credit card with a 0 percent introductory APR for 18 to 21 months. But if you can’t pay off your balance before the promotional period ends, it could make sense to take out a personal loan instead.

The bottom line: Should you use a personal loan for taxes?

The best option for paying the IRS is the one that will cost you the least amount of money in interest and fees. Calculate and compare the cost of a  personal loan versus a credit card or IRS payment plan to see which strategy works best for you.

Make some adjustments so that you don’t end up in the same position again. Start saving money throughout the year to cover any unexpected expenses. Ask your employer to withhold more taxes from your paycheck. If you’re self-employed, work with an accountant to figure out how much to pay in quarterly estimated taxes.

“Make those changes now so you never have to worry about this again,” Ingram advises.

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Written by
Libby Wells
Contributing writer
Libby Wells covers banking and deposit products. She has more than 30 years’ experience as a writer and editor for newspapers, magazines and online publications.
Edited by
Loans Editor, Former Insurance Editor