Loans to Pay Taxes: Your Options Explained

Finding yourself with an unexpectedly high tax bill can be stressful. You work hard all year anticipating a decent tax refund, only to learn at filing time that you actually owe money to the IRS. It’s an unpleasant surprise many taxpayers face at some point.

If you’re now trying to figure out how to come up with the cash to pay your tax debt, using a loan is one potential option. Loans to pay taxes allow you to get the funds you need upfront and then pay the money back over time.

In this comprehensive guide, I’ll walk through the ins and outs of using loans to pay taxes. As a financial advisor who has helped many clients deal with tax debts, I’ll share

• The different types of loans you can use to pay the IRS
• Key pros and cons of each loan option
• Tips for getting approved and picking the best loan for your needs
• Pitfalls to watch out for when borrowing to pay taxes

Let’s dive in!

Overview of Loan Options for Paying Taxes

Here are the main loan types people turn to when they need funds to pay tax bills

• Personal loans – Unsecured loans from banks, credit unions, or online lenders. Provide a lump sum and allow you to pay it back in fixed monthly payments.

• 401(k) loans – Allow you to borrow from your own 401(k) plan. Must be repaid within 5 years in most cases.

• Home equity loans/lines of credit – Secured loans that use home equity as collateral. Good option for homeowners with equity built up.

• Credit cards – Putting taxes on a credit card incurs fees but can provide quick cash access. Very costly long-term.

• Auto title loans – Risky loans where your car title is used as collateral. Should be a last resort option only.

• Payday loans – Provide fast cash up to a few hundred dollars. Dangerously expensive with sky-high interest rates.

Each loan type has pros and cons to weigh. I generally recommend exhausting safer options first before turning to riskier last resort loans like payday and auto title loans. Let’s explore the key details of each.

Personal Loans to Pay Taxes

Personal loans are one of the most popular options for getting funds to pay tax bills. Here are some quick facts about using a personal loan for taxes:

• Application – The process is quick and can often be completed online in under 10 minutes. Many lenders provide prequalification to see potential rates before a hard credit check.

• Funding time – If approved, you typically receive the loan within 1-7 business days via direct deposit to your bank account.

• Loan amounts – Personal loan amounts often range from $1,000 – $50,000, sometimes up to $100,000 based on income and credit score.

• Interest rates – Rates are fixed and competitive, often starting around 6-8% for those with good credit scores above 670.

• Terms – Repayment terms are usually 2-5 years. Longer terms have lower monthly payments but higher total interest costs.

• Fees – Some lenders charge origination fees of 1-6%. Always shop around for no-fee loans if possible.

As you can see, personal loans offer reasonably affordable rates and predictable repayment. Just be sure to only borrow what you can realistically afford to pay back.

401(k) Loans to Pay the IRS

If your employer’s 401(k) plan allows it, borrowing from your own retirement savings can provide another source of tax payment cash. Here are some key 401(k) loan guidelines:

• You can typically borrow up to $50,000 or 50% of your vested 401(k) balance, whichever is less.

• Most plans require you to repay the loan within 5 years.

• Payments are made back into your 401(k) account, including interest charged. This interest goes back into your own account.

• If you leave your job, the loan may have to be repaid immediately in full.

• Failure to repay the loan triggers income taxes and potential early withdrawal penalties.

While convenient, 401(k) loans reduce your retirement investing power. So only use this option sparingly as a last choice if possible.

Home Equity Loans and Lines of Credit

For homeowners with available equity, tapping home equity is another way to access large sums to pay taxes. Options include:

• Home equity loans – Second mortgages that provide a lump sum upfront. Repaid in fixed monthly installments over a set repayment term, usually 5-20 years.

• Home equity lines of credit (HELOCs) – Revolving credit lines secured by home equity. Allow you to draw money as needed and make interest-only payments until the draw period ends.

Both options put your home at risk if you default. Shop for the lowest rates and closing costs when choosing home equity financing.

Credit Cards to Pay the IRS

Charging taxes on a credit card is possible but not ideal in most cases. Here’s what to know:

• The IRS charges around a 2% fee for credit card tax payments. This eats into your total tax bill.

• Interest rates on credit cards tend to be much higher than other financing options, often 16% or more.

• Minimum payments on credit card balances are quite low, around 2% of your balance. This can take years to pay off a large tax bill.

Legitimate reasons to pay the IRS by credit card include earning rewards on your taxes or needing a very short-term cash flow bridge. But limit this to smaller tax balances you can quickly repay.

Riskier Loans: Payday, Auto Title, and More

In desperate situations, borrowers sometimes turn to risky loan types like payday, auto title, and tax refund anticipation loans. I never recommend these except as an absolute last choice since they come with exorbitant fees and interest rates. They also risk trapping you in a dangerous debt cycle.

If you’re considering one of these risky loans, please exhaust all other options first. Payday and auto title loans in particular must be avoided if at all possible due to annual percentage rates (APRs) of 300% or more in many cases.

7 Tips for Getting Approved and Finding the Best Loan

If you decide to use a loan to pay taxes, apply smartly. Here are my top 7 tips for securing approval for the best loan:

1. Know your credit score – For the lowest rates, you’ll generally need good credit (scores of 670+). Check your score before applying.

2. Calculate how much you need – Apply only for the exact loan amount required to cover your tax bill. Don’t borrow extra.

3. Check prequalification first – For personal loans and mortgages, many lenders offer prequalification checks without a hard credit pull. Use them to see potential rates.

4. Compare multiple lenders – Don’t take the first loan offer you get. Apply with at least 3-5 lenders for the best deal.

5. Opt for the shortest term possible – Paying loans off faster saves substantially on interest fees over the long run.

6. Automate payments – Setting up autopay from your bank can lower loan rates further and ensures you never miss a payment.

7. Read terms carefully before signing – Be 100% clear on all fees, APR, monthly payments, and other fine print before committing.

Avoid rushing into a loan choice without doing your due diligence. Getting the best rate and terms takes research and discipline.

Dangers of Using Loans to Pay Taxes

While loans to pay taxes are sometimes necessary, also be mindful of the hazards:

• High fees/interest costs – All loans charge interest and most also have fees. Minimize costs by only borrowing what you absolutely require.

• Credit score damage – Too many loan applications in a short time can lower your score. Space applications out over time when possible.

• Taking on more debt – Adding another monthly bill creates financial stress. Be sure you can truly afford the payments.

• Risk of default – Not repaying loans leads to financial ruin. Defaulting on secured loans risks losing collateral like your home or car.

• More taxes owed later – If borrowing from 401(k) or home equity, you may owe income taxes and penalties down the road.

Never rush into borrowing without carefully weighing these drawbacks against the benefits first.

When Loans for Taxes May Be Necessary or Smart

Though risky, borrowing to pay taxes does make good financial sense in some cases:

• You’ll face IRS penalties for nonpayment that exceed loan costs
• A one-time tax surprise won’t recur in future years
• You have ample income to comfortably afford payments
• The loan will help build your credit history

Loans probably aren’t the best path, however, if:

• You’ll carry a loan balance for many years
• The tax debt reveals broader financial issues you haven’t addressed
• You struggle with debt or have high existing monthly obligations
• Interest an