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Even if you prepare diligently, tax time can still be unpredictable. Just about everyone has been hit with a tax bill they never expected at some point. But what if you can’t afford to pay it right away?
One option is a personal loan, which can allow you to pay off your tax burden without breaking the bank in interest. We will indicate when this is the best strategy to use and when you will want to consider a different course of action.
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Benefits of using a personal loan to pay taxes
You can use a personal loan for several reasons, including wedding expenses, vacations, or paying your taxes. Here’s how a personal loan can help your taxes.
1. Can you borrow enough to pay off your tax bill?
The minimum amount available for a personal loan is generally between $ 500 and $ 1,000, and the maximum amount is generally $ 50,000. It also depends on the lender and your creditworthiness. If you have a good credit rating and a stable income, you may be eligible for up to $ 100,000.
2. Low interest rates available
Borrowers with good to excellent credit, around 710 or more, can benefit from an interest rate as low as 3%. Personal loan terms range from one to seven years, so it should be easy to find a monthly payment that fits your budget.
Related: Best Low Interest Personal Loans 2021
3. Simple application process
The application process usually takes a few days at most, and the money is often transferred to your bank account 24-48 hours after being approved.
Related: 5 personal loan conditions to know before applying
4. No risk of repossession
A personal loan is generally an unsecured loan, which means that there is no collateral or property attached. In other words, defaulting on a personal loan will not lead the bank to repossess your car or home.
5. Avoid dipping into your emergency fund
Even if you could tap into your emergency fund to cover the tax bill, using a personal loan preserves your savings. If you are at risk of losing your job or having other bills pending, it may be best to leave your fund for rainy days in an emergency.
Risks of using a personal loan to pay taxes
While there are many benefits to personal loans, there are also certain risks that you should consider first.
1. Could pay thousands of interest
Interest rates on personal loans vary depending on your credit score and income. If you don’t have a high credit score, you could be paid a double-digit interest rate. This can result in the payment of hundreds or even thousands of interest over the life of the loan.
For example, suppose you take out a personal loan of $ 5,000 with an interest rate of 10.93% and a term of five years. You would pay $ 1,512.26 in interest over the life of the loan, says the Forbes Advisor personal loan calculator, for a total amount of $ 6,512.26.
2. Could increase your DTI
Your debt-to-income ratio (DTI) is a reflection of your current debts relative to your income. You can calculate it by dividing your monthly debt payments by your gross monthly income. Every time you take out a loan and your income stays the same, you increase your DTI. This may affect your ability to qualify for a mortgage or other type of loan.
What if you can’t pay your taxes?
If you can’t pay your taxes, you should call the IRS and discuss your options. The worst thing you can do is avoid the problem because the tax issues get worse the more you ignore them.
Not paying your taxes can result in your salary, federal benefits, and future tax refunds being garnished on your paycheck. But if you talk to the IRS, they may be able to help you with a payment plan.
Alternatives to using a personal loan to pay taxes
Not sure if a personal loan is right for you? Here are some other options to consider if you owe taxes:
IRS payment plan
The IRS offers short and long term payment plans for consumers who cannot afford to pay their entire tax bill. Short-term payment plans have a maximum term of six months and no setup fees. They are available to taxpayers who owe less than $ 100,000.
Long-term payment plans last between six months and six years and are available for those who owe less than $ 50,000. Setup fees range from $ 31 to $ 225, depending on whether you’re making automatic payments or manual payments. You can use a debit card, checking or savings account, credit card, or money order.
The interest rate for IRS payment plans varies and is currently set at around 5%. If your credit is low, the rate for an IRS payment plan may be better than what you might receive with a personal loan.
You can pay your tax balance with a credit card, as long as the available credit limit is equal to or greater than your total tax bill.
Using a credit card may be the cheapest option if you qualify for an interest-free finance card. If you can pay off the balance before the interest-free offer expires, you may be able to avoid paying interest. Offers typically last between six and 24 months. If there is still a balance left after the offer expires, you will begin to earn interest at the normal rate on the card.
Using a credit card to pay your tax bill is one of the more flexible options, as the monthly minimum payment will likely be lower than the other options on this list. However, the interest rate on a credit card is higher, so you can pay more total interest if you don’t qualify for an interest-free offer. You can always pay more than the minimum payment if you can afford it.
401 (k) Loan
Taxpayers with a 401 (k) can take out a 401 (k) loan from their acquired balance. Generally, you can borrow the greater of $ 10,000 or 50% of your acquired account balance up to $ 50,000. The acquired balance includes your personal contributions and any employer contributions which belong entirely to you.
Unlike other loans, interest charged on a 401 (k) loan is deposited directly into your 401 (k) account, so it’s like paying interest yourself.
If you lose or quit your job, you will have to repay the remaining balance on tax day of the following year. For example, if you were laid off in May 2021, you would have until April 15, 2022 to pay off the balance.
If you cannot afford it, the remaining balance will be treated as a withdrawal. You may owe income taxes and a 10% penalty on that amount.
The downside to taking out a 401 (k) loan is that all the money you take out will stop growing in the market. This can affect your retirement schedule, especially if you don’t focus on rebuilding your nest egg after the loan is paid off.