Should You Use a Personal Loan to Pay Taxes?

An expensive tax bill can cause a lot of financial stress, especially if it’s unexpected.

If you don’t have enough savings, a personal loan may seem like a good way to settle the bill, but you may have cheaper options.

Here’s what to know about using a personal loan to pay taxes, plus alternatives to consider.

Can you use a personal loan to pay taxes?

You can use a personal loan for a wide variety of reasons, including paying a tax bill. Some lenders prohibit using a personal loan for certain expenses, like higher education costs or investments, but taxes generally aren’t among them.

A personal loan may seem appealing because it can make a large tax bill more manageable by spreading the cost over time. However, because interest rates can be high — some lenders charge annual percentage rates up to 36% — it’s worth your time to consider other options.

You also might want to rethink using a personal loan to pay taxes if you only owe a few hundred dollars. Personal loan amounts typically start around $1,000.

» MORE: How to get a personal loan

Pros and cons of using a personal loan to pay taxes

Pros

Quick funding.

Avoid IRS penalties.

Fixed monthly payments.

Cons

APRs may be high.

Possible fees.

Missed loan payments can damage your credit.

Will increase your DTI.

Pros of using a personal loan to pay taxes

Quick funding: Funding times vary, but most lenders can fund a personal loan within a week. Some lenders can fund a loan the same day you’re approved.

Avoid IRS penalties: You’ll avoid paying IRS penalties, which can add up.

Fixed monthly payments: Personal loans are fixed-rate installment loans. This means you’ll have consistent monthly payments throughout your loan term, which is usually two to seven years. Having the same payment each month makes it easy to budget for.

Cons of using a personal loan to pay taxes

APRs can be high: Personal loan interest rates can be high, especially for consumers with poor credit scores (below 630) or thin credit histories.

Possible fees: Some lenders charge origination fees to cover the cost of processing a loan. Origination fees typically range from 1% to 10% of the total loan amount, and many lenders deduct the cost from the loan proceeds, leaving you with a smaller amount.

Missed loan payments can damage your credit: Unlike being late on your taxes, which initially has no impact on your credit, a late or missed personal loan payment could cause your credit score to drop significantly.

Will increase your DTI: A personal loan increases the amount of debt you have, which means your debt-to-income ratio will rise. If you plan to get another form of financing in the future — like a mortgage or auto loan — a high DTI may prevent you from qualifying.

What happens if you can’t pay your tax bill

The IRS charges you interest and penalty fees if you don’t pay your taxes by the deadline.

Interest: The IRS charges interest on the unpaid tax bill, equal to the federal short-term rate plus 3%. The interest rate can change each quarter but has most recently been set at 7% or 8%.

Fees if you file but pay late: The failure-to-pay penalty is initially 0.5% of the unpaid amount per month, with the ability to increase to 1%. This penalty fee is capped at 25% of the unpaid tax amount.

Fees if you don’t file: If you owe taxes but don’t file your return at all, you’ll be charged 5% of the amount owed monthly, up to a maximum of 25% of the unpaid amount. Those who are over 60 days late could also owe a late-filing penalty of either $510 or 100% of the amount owed, whichever is less.

If you don't pay for a prolonged period, the IRS can resort to more severe actions, including wage garnishment, bank account seizure and tax liens against your property.

Fees if your payment bounces: If you make a tax payment but don’t have enough money in your account to cover the amount, you face a 2% penalty fee if your tax bill is $1,250 or more. If you owe less than $1,250 and have insufficient funds for your tax bill, the fee is $25 or your payment amount, whichever is less.

» MORE: 10 ways to pay your taxes

Alternatives to using a personal loan to pay taxes

A personal loan isn’t the only solution if you have a tax bill you can’t afford to pay. Here are several alternatives.

IRS payment plan

An IRS payment plan is a deal you make with the IRS to pay your tax bill over time. There are short-term IRS payment plans for taxpayers who owe less than $100,000 and can pay the balance in 180 days. There are also long-term payment plans for those who owe less than $50,000 but need more than 180 days to settle the bill.

Requirements for IRS payment plans

To enroll in an IRS payment plan, you need to fill out the online application or contact the IRS directly. For a long-term plan, you may need to also submit an installment agreement request (Form 9465). You can set up monthly payments via payroll deductions or direct debits from a bank account. You can also choose to pay by credit or debit card, check, money order or cash at a retail partner.

Benefits and downsides of IRS payment plans

IRS payment plans let you spread the amount you owe into smaller payments without involving a third-party lender. Interest and penalties on your unpaid tax bill still accrue while you’re on an IRS payment plan, but the late-payment penalty drops to 0.25% per month.

There are also fees involved with setting up a long-term plan: $22 if you enroll in an automatic withdrawal plan or $69 if you don’t. Low-income taxpayers may get some or all of those fees waived.

Zero-interest credit card

A zero-interest credit card may be an affordable way to pay an expensive tax bill over several months, as long as you pay the balance before the card’s zero-interest promotional period ends — typically the first 15 to 21 months.

» MORE: Best 0% APR credit cards

Requirements for zero-interest credit cards

Most credit card companies require borrowers to have good credit (a score of 690 or higher) to qualify for a zero-interest credit card. An issuer may also consider factors like borrowers’ income and employment status.

Benefits and downsides of zero-interest credit cards

Using a zero-interest credit card can be one of the least expensive ways to cover a tax bill, provided that you pay off the entire bill before the promotional period ends. Whatever balance you carry over can be subject to a double-digit interest rate.

You’ll also have to pay a processing fee — typically less than 2% of the amount owed — if you use a credit card to pay your tax bill.

» MORE: Pros and cons of a 0% interest credit card

401(k) loan

If you have a retirement account through your employer, you could consider getting a 401(k) loan to cover the tax bill. You can typically borrow up to half of your account balance or $50,000, whichever is less, for up to five years.

Requirements for 401(k) loans

To take out a 401(k) loan, your vested balance must be at least double the amount you need to cover your taxes. You must be able to make quarterly payments.

Benefits and downsides of 401(k) loans

A 401(k) loan can be a quick way to access needed funds. There’s typically no credit check, your APR is likely to be lower than with a personal loan and the interest you pay goes back into your retirement account.

However, if you lose your job or leave the company, you may have to repay your loan immediately or be subject to early withdrawal penalties. You’ll also hinder potential growth of your investment portfolio if you take money out to cover your tax bill.

Home equity loan or line of credit

A home equity loan and a home equity line of credit (HELOC) are both types of secured financing where you use your home as collateral.

A home equity loan is a type of installment loan where you get a lump sum of money at a fixed interest rate and monthly payments are consistent throughout the length of your loan term.

A HELOC is a type of revolving credit you can continuously draw upon until you reach your credit limit. Interest rates and monthly payments are usually variable.

Requirements for home equity financing

To qualify for home equity financing, you need to be a homeowner and typically have at least 85% of equity in your home. You usually need an appraisal to confirm the current value of your home.

You also must meet a lender's credit and income requirements, but they’re generally softer than unsecured personal loan requirements.

» MORE: Requirements for a home equity loan and HELOC

Benefits and downsides of home equity financing

Home equity financing often comes with lower interest rates than unsecured loans. But if you default on your home equity loan or HELOC, you could lose your home. It also takes more time to get money with home equity financing, because the underwriting process includes more steps, like a home appraisal.

» MORE: Compare home equity loans

Family loan

If you have a trusted family member who can afford to help you out, consider asking for a family loan. This borrowing method may feel informal and it can be awkward to ask loved ones for money, but this can be a quick, low-cost way to get the funds you need to cover a tax bill.

Requirements for a family loan

A family loan doesn’t have the strict requirements that a formal lender may have. This makes family loans ideal for people who may not have a good credit score or meet other requirements from a financial institution.

Even though a family loan is more informal, it’s a good idea to draw up a loan agreement so both parties are clear on how the money will be repaid.

Benefits and downsides of a family loan

A family loan can come with little to no interest, making it a cheap way to borrow money. It can also be a quick way to borrow if your loved one has an easily accessible source of cash.

The big risk in using a family loan is damaging your relationship with your loved one if you aren’t able to pay back the money. Make sure you have a plan for making payments and discuss in advance what would happen if you aren’t able to pay.

» MORE: The best ways to borrow money