Is Using a Personal Loan for Taxes a Good Idea?

If you’re raising a kid on your own, you’ve got enough to worry about without having to figure out how to pay your taxes if you owe Uncle Sam money.

With the tax deadline extended until May 17 because of COVID-19, you have a little more time to figure out how you’ll cover the costs. But remember, that’s the deadline not only to file your taxes but also to pay your taxes. Otherwise, you could face late fees and have to deal with the IRS.

In a recent Credello survey of 1,000 Americans, 25% of single moms said their biggest fear when filing taxes was making a mistake. About 21% said their biggest fear when filing taxes was that they’d owe money or that the IRS would come after them.

If you’re concerned about owing money, taking out a personal loan to pay your taxes is an option. But is it wise?

Why consider using a personal loan for taxes?

Rates and terms for personal loans vary by lender and individual financial circumstances, like your credit score. That said, a fixed monthly payment, loan term, and interest rate could fit your needs because it offers predictability. Additionally, with an unsecured personal loan, you don’t have to worry about putting up your house or car as collateral if you’re unable to make payments. 

It’s also possible that a personal loan could ultimately cost less than an IRS installment plan or paying with a credit card. Credit card interest rates tend to be significantly higher, with the average annual percentage rate hovering above 16%, according to the Federal Reserve. Meanwhile, the average personal loan APY is 9.34%, per the Fed.

But be mindful that personal loans can come with origination fees and other potential penalties.

What to look for in a personal loan

When looking for a personal loan, you want to shop around. You wouldn’t buy a new pair of shoes or handbag without comparing prices from different retailers, right? The same is true here.

Factors to look at when applying for a personal loan include:

  • Minimum and maximum borrowing limits: How much do you owe the government? Personal loans can range from about $1,000 to $100,000, but not every lender will have that wide of a range.
  • Does the lender offer unsecured or secured loans? Unsecured loans don’t have collateral, while secured loans do.
  • Interest rates and fees: You already know interest rates can vary by lender, but so can fees. Some lenders charge a gamut of fees, including origination, late, prepayment, and returned payment fees, while others have no fees at all.
  • Loan terms: This is how long you’ll have to repay your loan. Loan terms typically range from 12 to 84 months.
  • Credit score and income requirements: It’s possible to qualify for a personal loan with a subpar credit score, but the better your score, the better your odds will be. A better score will also help you qualify for a better interest rate. As with just about everything, income requirements vary by lender, but some lenders have a minimum income requirement as low as $20,000/year.

Pros of using a personal loan to pay taxes

If you’re comparing using a personal loan vs. an IRS payment plan to pay your taxes, there are some advantages:

  • Avoid IRS failure-to-pay penalty and interest: The failure-to-pay penalty is 0.5% of your unpaid taxes, charged monthly until your taxes are paid in full
  • Personal loans typically have clearer terms than an IRS installment plan
  • Avoid the IRS garnishing your wages or filing a tax lien against your house

Cons of using a personal loan to pay taxes

Of course, it’s not all sunshine and rainbows if you go the personal loan route to pay your taxes—there can be some downsides too:

  • Factoring a new monthly loan payment into your budget and could put a strain on your finances
  • If you don’t have a great credit score, you could be subject to higher interest rates
  • Defaulting on a loan can hurt your credit score and take 7 to 10 years to fully recover, according to a FICO study

Personal loan vs. IRS payment plan

The IRS offers two individual payment plans: a short-term and long-term option. To qualify for a long-term payment plan, you must owe $50,000 or less in combined tax, penalties, interest, and filed all of your necessary returns. The long-term payment plan is an installment agreement paid monthly until you’ve paid in full.

The short-term payment plan is available if you owe $100,000 or less combined. In this case, the IRS requires you repay what you owe in 120 days or fewer, about four months.

Short-term payment plans don’t charge a setup fee, but long-term payment plans cost either $31 if it’s an automated payment or $149 if it’s not a direct debit. There are some circumstances where fees are waived or can be reimbursed for low-income earners. Of course, in both cases, you’ll face accrued penalties and interest until you’ve completely paid off your debt.

How else can you pay your taxes?

If you don’t want to take out a personal loan or get wrapped up in an IRS payment plan, you could consider using a credit card to pay your tax bill.

The downside of using a credit card is you’ll have to pay a processing fee, which ranges from 1.87% to 1.99%, with a minimum of $2.50. On the bright side, that fee can be tax deductible.

If you plan ahead, you could apply for a new credit card with a 0% introductory APR offer to avoid paying interest if you’re able to pay off your balance within the intro period. Alternatively, you could try to open a new card with a signup bonus to easily rack up rewards.

Even if you don’t open a new account, which can potentially ding your credit score temporarily, you could see some benefits from using a credit card. The cash-back rewards, miles, or points you could earn from your transaction could cover the cost of any associated fees.

In a last-ditch effort, you could think about borrowing money from family or friends. This can get complicated, but depending on how much you owe and how close you are with said family member or friend, they might be happy to help. Not to mention, they likely aren’t going to charge you interest or late fees. Still, it’s a good idea to work out a set repayment plan to protect one another and your relationship.

How to avoid owing money in the future

Nobody likes owing anyone money. And owing the government money is the (Jean-Ralphio voice) wOoOoOrst. So, how can you avoid getting hit with a tax bill in the future?

You can contact your employer to adjust your W-4 withholding. In some cases, you can do this yourself through your company’s intranet or HR web portal. Make sure your information, like number of dependents, is accurate. 

For those who are self-employed, you may want to consider adjusting your estimated quarterly taxes or working with a tax expert to make sure you’re not missing any ways to optimize your deductions.


-Federal Reserve


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