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Using a Personal Loan to Pay Tax Debt: Pros and Cons

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Tax season is met with both anticipation and dread, depending on whether you owe money or expect a refund. People who need to repay the IRS are left in a tough situation: How do you repay the tax debt while juggling your other bills?

One way to repay your tax debt is with a personal loan. These unsecured installment loans are a fast way to get the funding you need to repay the IRS, though they typically carry higher APRs than you would pay with other financing options.

Should you use a personal loan to pay off tax debt?

A personal loan is an unsecured financing option that gives you the funds you need fast. Because it’s unsecured, there’s no collateral, and lenders rely heavily on your credit history to evaluate your ability to repay the loan. Borrowers with prime credit scores and favorable debt-to-income ratios will get the best terms on a personal loan, but low-credit borrowers will see high APRs.

Generally, you should exhaust your other options — such as enrolling in an IRS payment plan — before getting a loan to pay off IRS debt. Here’s why.

Pros of opening a personal loan to repay tax debt

Personal loans can be used to pay for virtually anything, which makes them an option for paying down tax debt. Here are a few benefits of using a personal loan to pay back the taxes you owe:

  • You can get the money you need quickly, sometimes as soon as the same day you apply
  • You’ll clear your debt with the IRS, which means they can’t levy your property or charge you a failure-to-pay penalty
  • You’ll pay off the debt in equal monthly installments, since personal loans have fixed APR and monthly payments

Plus, depending on your creditworthiness, you may be able to secure an APR of 10% or less, though that’s not typical among most borrowers.

Cons of paying tax debt with a personal loan

The biggest drawback to personal loans is that they have relatively high APRs compared with secured loans like auto loans and mortgages, for example. Because of APRs, personal loans are less favorable when compared to other options for paying back your tax debt, including IRS repayment plans. This is particularly true for borrowers with subprime credit, who will see the highest APRs.

APR affects the overall cost of the loan, so it’s important to factor this into your decision to use a personal loan to pay back tax debt. See just how much a fair credit score borrower will pay over the life of a loan compared to an excellent credit borrower:

$10,000 personal loan cost: Excellent credit vs. fair credit

Excellent credit borrower (760+ credit score)Fair credit borrower (640-679 credit score)
Loan amount and terms$10,000 over 5 years$10,000 over 5 years
Average best APR*9.96%24.49%
Monthly payment$212 $291
Total cost of the loan$12,736 $17,432
Amount paid in interest$2,736 $7,432

* According to LendingTree’s Personal Loans Offers Report, Jan. 2020.

In most cases, you’ll pay more in interest on a personal loan than you would on failure-to-pay penalties and account setup fees from the IRS. While a personal loan could be a good tool for something like debt consolidation, it’s not always favorable to use a loan to pay tax debt.

Other options for repaying tax debt

Entering an IRS repayment plan

Before you open a personal loan to repay your tax debt, you should consider enrolling in an installment agreement through the IRS. Doing so could cut your failure-to-pay penalty in half, from 0.5% per month to 0.25% per month until the balance is paid in full. This also helps you avoid paying interest on your tax debt, which would be incurred if you opened a personal loan.

People who owe the IRS have two options for repayment plans: a short-term installment agreement and a long-term installment agreement.

IRS repayment plans: Long-term vs. short-term

Short-term payment planLong-term payment plan
Amount owed
  • Less than $100,000 in combined tax, penalties and interest.
  • Less than $50,000 in combined tax, penalties and interest.
Length of the payment plan
  • Less than 120 days.
  • More than 120 days.
Fees charged*
  • Free to set up online, by mail, over the phone or in-person.
If payments are processed through a Direct Debit Installment Agreement:
  • $31 to set up online
$107 to set up by phone, mail or in-person** If plan payments are made via another method:
  • $149 to set up online
  • $225 to set up by phone, mail or in-person**

* You’ll play interest and penalties until your balance is paid in full, in addition to costs under your payment plan.
**Lower-income applicants may qualify for reduced fees.

Charging a credit card

Under certain circumstances, using your credit card could be the best way to repay your tax debt. Consider the following:

  • You can utilize a credit card with a 0% APR introductory period without paying any interest at all, as long as you pay back the debt by the time that introductory period is over.
    • If you don’t repay the debt on time, you could end up paying deferred interest all the way back to the time when you charged the tax debt to your card.
  • Not all borrowers will qualify for a credit card that has a no-interest APR period, as they require strong credit.
    • The average APR for new credit card offers is 20.44%, according to CompareCards, a subsidiary of LendingTree. It’s not a good idea to charge your credit card if you can’t take advantage of a no-interest promotion.
  • You’ll pay a fee when you pay your tax debt with a credit card, ranging from 1.87% to 1.99%, depending on which service you use to process the payment.

Borrowing from friends or family

Not everyone has the luxury of borrowing money from friends or family. But if you can give it a shot, this method could pay off. That way, you can avoid credit inquiries, interest, penalties and levies on your assets. Just make sure you have a clear plan for repayment. You don’t want your tax debt to spoil a close relationship.

 

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