Tax season can be met with excitement or dread, depending on whether you’re owed a refund or you owe money to the IRS. And when you owe more money than you can comfortably afford, you may be wondering how to pay your excessive tax debt.
One way to square away your tax bill is by taking out a personal loan, which allows you to borrow a lump sum of money that you repay in fixed monthly payments with interest over a set period of months or years. Although it’s technically possible to pay your tax debt with a personal loan, there may be better repayment strategies available, such as IRS installment agreements, hardship programs and secured loans. Compare your options in the analysis below.
[Read: Best Personal Loans.]
What to Know About Using a Personal Loan to Pay a Tax Bill
It’s possible to use an unsecured personal loan to repay all or some of your unpaid tax debt. Doing so could help you avoid late-payment penalties and more serious nonpayment consequences, such as wage garnishment. But the cost of borrowing a personal loan often outweighs the interest and fees you would pay through IRS programs and other repayment options.
Since personal loans usually don’t require collateral, lenders determine your eligibility and borrowing terms based on your financial history, including your credit score and debt-to-income ratio. Applicants with very good or excellent credit may be able to lock in a competitive interest rate on a personal loan, while those with fair or bad credit will see high rates — if they are able to qualify at all.
Additionally, some lenders charge an origination fee, typically worth up to 5% of the amount being borrowed. You may be able to pay this fee upfront, or the lender can subtract it from your disbursed loan amount. See how different loan lengths and interest rate impact the personal loan monthly payments and overall interest paid in the scenarios below for a $4,000 loan:
| Personal Loan A | Personal Loan B | Personal Loan C | |
| Repayment Term | 24 months | 36 months | 60 months |
| Interest Rate | 8.99% | 12.99% | 17.99% |
| Monthly Payment | $183 | $135 | $102 |
| Lifetime Interest Paid | $385 | $851 | $2,093 |
| Total Cost of Loan | $4,385 | $4,851 | $6,093 |
[CALCULATE: Use Our Free Loan Calculator to Estimate Your Monthly Payments.]
Personal loans can offer fast funding, with loan payout disbursed directly into your bank account as soon as the next day after approval. But after you pay interest and fees, taking out a personal loan to pay your tax debt can be unnecessarily expensive. If you do decide to take out a personal loan to repay tax debt, there are a few tips for getting a low rate:
— Shop around with multiple lenders. Most (but not all) lenders let you get prequalified to see your estimated interest rate and terms with a soft credit check, which won’t impact your credit score. This effectively allows you to shop around for the lowest possible interest rate before applying for a personal loan.
— Improve your credit before applying. Because personal loan rates are influenced greatly by an applicant’s credit history, it’s crucial to take steps to boost your credit score before you borrow, especially if you have fair or bad credit. You can build better credit by improving your on-time payment history, reducing your credit utilization rate or opening a secured credit card, for example.
— Reach out to your credit union. Unlike for-profit banks and online lenders, credit unions are nonprofit and member-owned. Because they exist to serve their members, credit unions are usually able to offer lower rates and reduced fees on personal loans. Plus, some credit unions may look at factors besides your credit score, such as your history as a member.
Still, it’s important to consider your alternatives before paying your tax bill with a personal loan. You may be eligible for low-interest payment plans, tax debt settlement or even a 0% annual percentage rate credit card promotion.
Alternative Ways to Repay Tax Debt
File for a Short-Term Extension
— Best for: Those who can repay their tax bill in full within four months of the tax-filing deadline.
Taxpayers who just need a few more months after the April 18 deadline to repay their tax debt are able to file for a 120-day extension. There’s no fee to apply for a short-term extension, but you’ll need to submit a request online using IRS Free File or fill out and mail Form 4868 to get it started. If your tax bill is $100,000 or more, you’ll need to ask for an extension by phone, mail or in person.
The IRS charges interest at the federal funds rate plus 3% per year, compounded daily until the debt is paid in full — the current rate is 7%. Additionally, you’ll pay a late-payment penalty worth 0.5% of the outstanding tax balance for each month the debt remains unpaid. However, this penalty fee may be waived if you can prove reasonable cause for failing to pay your taxes on time.
Take this example: Let’s say you have $4,000 worth of outstanding tax debt. By filing a tax extension starting April 18, you’d have to pay the balance by Aug. 16. If you use all the time in the extension — that is, if you don’t make any early payments and just pay the full due balance on the final day it’s due — you’d accrue around $93 in interest and $80 worth of penalties.
Enroll in a Longer-Term IRS Repayment Plan
— Best for: Those who need more time to pay their tax bill in monthly payments.
If you can’t pay your tax balance in full within 120 days of the filing deadline, you may be able to break the debt into multiple payments through an IRS installment agreement. This allows you to make fixed payments for up to 72 months until the balance is repaid. The upfront application fee can be steep, though, at $130 (or $43 for low-income taxpayers). However, if you set up automatic payments through direct debit, the fee is reduced to $31 and is waived for those who meet the income requirements.
Like with the short-term extension, you’ll pay interest on the balance at the current 7% rate, but the late-payment penalty is reduced to 0.25% per month. To enroll in an installment agreement for a tax bill of $50,000 or less, you can apply online by logging into your account on the IRS website, or by filling out and mailing Form 9465. If your tax bill exceeds $50,000, you’ll need to apply by phone, mail or in person.
Apply for IRS Hardship Programs
— Best for: Those who can’t afford a tax bill due to sustained economic hardship.
Hardship extension: If you’re unable to pay your tax bill in full by April 18, you may be able to request an economic hardship extension using Form 1127. But the definition of undue hardship is vague. The IRS says a taxpayer must show “substantial financial loss” if the taxes must be paid on the due date.
Currently not collectible, or CNC: If you owe taxes that you can’t repay, the IRS may put your account in CNC status. Under this protection, the IRS won’t attempt to collect the debt through wage garnishment or asset seizure, but your tax bill will still accrue fees and penalties. You’ll need to call the IRS to determine whether you qualify for CNC status.
Offer in compromise, or OIC: You may be able to settle your tax debt for less than you owe with an OIC. The IRS will determine your eligibility based on a few factors, including your income, expenses and assets, as well as your ability to repay. But manage your expectations: the IRS accepted just 31% of OICs in 2021. You can see if you’re a good candidate for an OIC with this prequalifier questionnaire from the IRS.
Use a 0% APR Credit Card Promotion
— Best for: Those with excellent credit who want to pay their tax bill over time while avoiding interest charges.
You can pay taxes with a credit card, but this strategy is only advisable under the right circumstances. If you charge your credit card and let the balance accrue interest, you could end up paying hundreds of dollars extra on top of your tax bill. But if you have excellent credit and can qualify for a 0% APR credit card offer, you can potentially repay your tax bill over time without paying interest at all.
Zero-interest credit card promotions are available when you open a new account, and they typically last up to 21 months. As long as you repay the balance in full before the introductory offer expires, you won’t pay a dime in interest. Any balance left over after the promotional period ends will be charged the regular purchase APR, which can be upward of 20%.
You should also consider whether the credit card carries an annual fee or other charges, such as late fees. And keep in mind that you’ll need very good credit to qualify for these offers, usually a FICO score of 740 or higher.
[Read: Best Credit Cards.]
Tap Your Home’s Equity
— Best for: Those who own a home with sufficient equity and want a lower interest rate on a loan to repay taxes.
Homeowners with at least 20% equity in their home can potentially use a home equity loan or line of credit to pay off tax debt. Since you’re borrowing against a secured asset — your home — you may qualify for lower interest rates and overall borrowing costs than you’d get with an unsecured personal loan.
But tapping into your home’s equity doesn’t come without risk. If you can’t make payments and you go into default, you can potentially lose the roof over your head. Plus, you’ll still likely pay more interest and fees than if you entered an installment agreement through the IRS.
[Read: Best Home Equity Loans.]
Borrow From Your Retirement Account
— Best for: Those with steady employment and a thorough understanding of their retirement plan’s borrowing agreement.
Pulling money from your retirement nest egg can be one way to pay your tax bill, but tread carefully. The benefit of a 401(k) loan is that it’s relatively inexpensive, since you’re paying a low interest rate — typically just a point or two above the prime rate. Plus, since you’re borrowing from your own savings fund, you pay interest back to yourself.
That being said, borrowing a 401(k) loan comes with a number of risks and downsides. If you quit or lose your job while repaying the loan, the entire balance can become due before you next file taxes. And if you can’t repay the loan when it’s due, you could get hit with income taxes on the remaining loan amount and a 10% early withdrawal penalty. There’s also the opportunity cost, which is the loss of potential interest earnings when you withdraw money from your retirement account. Finally, not all 401(k) plans allow you to take out this type of loan.
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Should You Use a Personal Loan to Pay Your Tax Bill? originally appeared on usnews.com
Update 02/21/23: The story was previously published at an earlier date and has been updated with new information.
