Should I Use a Loan to Pay Taxes?

First Republic Bank

February 18, 2021

When you have a tax liability due in April, it can be a significant drain on your cash on hand. Quarterly or semi-annual tax schedules and fluctuating cash flows can also be a challenge, as can discovering a capital gains obligation or higher than anticipated property taxes. The right type of loan can go a long way to alleviate the financial and emotional stress associated with such bills.

For high-earning savers with excellent credit scores, there are numerous benefits to borrowing money at a low interest rate to cover major obligations. Whether for income or property taxes, a loan or personal line of credit can act as back-up funds. Depending on the type of loan you get and the way you use it, the interest charges can be minimal. And although the loan account will be listed on your credit reports, your consistent payments will protect your credit scores. In fact, with the right tax financing, you can assume control of your monthly cash flow, reduce anxiety around hard-to-predict expenses and avoid costly fees.

What is the best way to pay my taxes?

In general, the ideal way to manage taxes is to set aside enough cash for the entire amount you owe. As a debt, income taxes often take priority because of the penalties. If you underpay or are delinquent on your income taxes, the IRS will assess a variety of interest and penalties, some of which will continue to accrue until the debt is paid in full.

There are several ways of financing tax payments; in general, the stronger your financial standing, the more favorable terms you may receive from lenders, so it's important to explore all the options available. For example, you may tap into savings, take out a loan, use a credit card, withdraw funds from your retirement plan or borrow against it.

Income taxes aren’t the only tax debt that can cause a financial headache, however. As a homeowner, property taxes are part of the package. Typically you would send a single payment that includes your mortgage, insurance premiums and property taxes into an escrow account. Keeping up with those payments is essential because if you fall behind, your home may be in jeopardy of foreclosure.

For professionals managing a wide variety of financial and household responsibilities, paying both income and property taxes when each is due can be as stressful as it is serious. The right kind of tax financing can provide you flexible access to funds when you need them, and help you achieve your long -term financial goals faster.

Methods to Pay Taxes

To decide the best way to pay your taxes, review the benefits and drawbacks of the most common methods. For the financing options, be sure to calculate the final cost after paying it over time and with the estimated interest rate. The faster you pay off the debt and the lower the Annual Percentage Rate (APR), the less it will cost you in the long run.

Payment Method	Benefits	Drawbacks
Savings	Does not require taking out a loan or line of credit No added interest or fees	Amount saved may not be enough to pay the full balance Can reduce money necessary for other purposes, such as investing, essential purchases and long-term goals
Personal line of credit	Flexible payment terms Low interest rates (even better if they're low and fixed), compared to credit cards Remaining funds can be used to finance other personal and household expenses No prepayment penalty Interest incurred only on funds borrowed	Requires a good to excellent credit score to qualify for low rates Typically available to highly-qualified borrowers
Personal loan	Fixed monthly payment Low interest rates for qualified borrowers Flexible use of funds	High interest rate for credit-challenged borrowers Long payment term will result in an expensive loan May include a prepayment penalty
Federal or state tax installment arrangement	Eligible for income tax of $50,000 or less Short-term plans for tax debt payable less than 120 days. Long-term payment plans for tax debt payable in more than 120 days.	Short-term plan: no set-up fee, but penalties and interest will continue to accrue until balance is paid in full. Long-term plan: set-up fee plus penalties and interest. Missing payments can end plan prematurely
Credit card	New card with introductory 0% APR gives time to pay without interest added Earn sign-up rewards Can make small monthly payments possible	The average APR for a credit card is 14.52% but can go much higher Fees added to debt Good credit required for new 0% APR card APR can reach the double-digit range if the debt isn't paid off within the introductory period Credit lines may not cover larger debts High debt to limit ratio will hurt credit scores
Retirement plan withdrawal	No loan application or credit check required No interest added Access to potentially large amount of money, depending on funds saved	10% penalty fee if money is withdrawn before age 59 ½ Income tax usually assessed on amount withdrawn Deplete savings required for retirement years
Retirement plan loan	Can borrow 50% of account balance up to a maximum of $50,000 Loan terms usually five years or less Not listed on credit report Typically 5 years to repay Interest assessed (prime plus 1 or 2 percentage points), paid to self	Forfeit potential plan growth Missed payments can result in default, then treated as a distribution- income tax will be assessed on balance If you change employers or lose your job, loan balance due within 60 days or it will be considered a distribution and income tax will be assessed on balance, plus additional 10% penalty tax if you are under the age of 59.5

Can I use a loan or personal line of credit to pay property taxes?

You can use the funds from a personal loan or a personal line of credit to cover your property tax liability. With an installment loan, you would borrow a lump sum to use for the debt, and interest is included in the fixed monthly payments. Personal lines of credit, on the other hand, are more flexible. You can draw as much as you need up to the credit line during the draw period, and interest will only be assessed on the amount you use.

Being able to borrow money for property taxes can be especially helpful because these bills can be so high especially for first time homeowners in areas with expensive property values. Property taxes are calculated on the assessed value of your home, and the money is used by local and state governments for such necessities as schools and public transportation. The average percentage of property tax assessed across the U.S. is approximately 1.1% but can be much higher.

To illustrate how big property tax assessments can be in areas where the home value is high, consider these examples:

An apartment on New York City’s Upper West Side — a neighborhood rich with top-rated schools, well-tended parks, low crime and excellent public services — might be valued at $2,350,000. With a property tax percentage of .88%, the annual property tax bill would be roughly $20,000.
On the other side of the U.S. is an equally expensive city: San Francisco. A home in the outer Sunset District, located just a few blocks from the Pacific Ocean and Golden Gate Park with easy transit access, may be valued at $1,200,000. With a property tax percentage of 1.2%, the property tax obligation would be about $14,500.

With such sizable property tax bills, the option to use a loan or draw from a credit line to pay for all or some of it can be comforting.

To manage the burden of both income and property taxes, it’s wise to explore loans and personal lines of credit if you're concerned you can’t pay the tax bill in full without pulling from hard-earned savings. When used prudently, these credit products can ensure complete and on-time tax payments, while freeing up your liquidity to put towards other financial goals, such as making minor home improvements or upgrading your car.

Do I have to pay taxes on a personal line of credit?

You can use the money from a personal line of credit for a broad range of personal or household expenses, including paying income and property taxes. Under most circumstances, you will not be assessed any additional taxes on your personal line of credit.

One exception to that rule is if you do not pay back the money you borrowed during the repayment period and the lender forgives a portion of the balance. If you were to settle the debt for less than you actually owe, the IRS may consider the forgiven amount as income, in which case you may have to pay taxes on that forgiven sum. Other than that, a line of credit is just a loan, which is not a taxable event.

How long will it take to pay my taxes using different methods?

Financing tax bills is more expensive than using cash because you will be paying at least some interest, so calculate the potential cost before borrowing any money. Each method comes with different payment schedules, as well as interest and fees, all of which will increase the total amount you pay.

Be especially cautious when using a credit card for a tax bill. In addition to the processing fee that the IRS will charge, interest rates can be prohibitive, so you’ll want to be sure to pay off the balance quickly. The average APR for a credit card is 14.52% but can go much higher. Drag the debt out and the final cost can be enormous. A $5,000 credit card debt at 14.52% APR would take just over 10 years to repay, and cost you thousands in interest if you only make the minimum payments. One way around such costs is to take out a new credit card. If it has a 0% APR for a fixed number of months, you have time to pay the debt down with no financing fees and earn a valuable signup bonus. But if you don’t repay it before interest kicks in, beware: APRs can easily rise to the 20% mark.

So while the credit card option may be easy and available, weigh it against loans with low APRs and far shorter repayment timeframes. Typical unsecured loans with fixed payments have average interest rates of 9.34%, based on a 2-year payment term.

Installment loans, however, can be too restrictive, especially when you’d like to free up your money for other needs. Therefore, a personal line of credit may be the preferred choice. Not only do these products usually offer the lowest interest rates, but interest is only calculated on the amount you borrow, and the payments are flexible.

For example, First Republic’s Personal Line of Credit has low fixed rates of 2.25%-3.5% APR, with discounts¹. In addition, you can access money from the line during the two-year draw period, giving you an opportunity to directly pay off your taxes and better manage your monthly cash flow. During those two years, you'll make interest-only payments; if you pay off what you borrowed within that time frame, you'll have access to those funds again during the draw period, without the requirement to reapply for another loan.

Use a Personal Line of Credit to pay your taxes

A smart tax payment strategy can give you the peace of mind that you’re able to meet your tax obligations and stay on track with your big-picture financial goals. Monitor your finances regularly, and set cash aside for projected taxes. Highly qualified borrowers with strong credit scores have access to financing options with favorable terms; research what is available to you based on your credit score and financial circumstances, then select the option that makes the most sense for you.

With tax season coming in April, it pays to be prepared several months in advance. Save yourself the scramble of figuring out last-minute tax payment options; your future self will thank you.

A personal line of credit rises to the top because it offers so many benefits. Calculate your rate now to see how a personal line of credit can put your mind at ease and ensure a strong financial picture, not just when tax bills are impending, but long into the future.

1. Annual Percentage Rate. Rates effective as of 06/15/2020 and are subject to change.

Borrower must open a First Republic ATM Rebate Checking account (“Account”). Terms and conditions apply to the Account. If the Account is closed, the rate will increase by 5.00%. Rates shown include relationship-based pricing adjustments of: 1) 2.00% for maintaining automatic payments and direct deposit with the Account, 2) 0.50% for depositing and maintaining a deposit balance of at least 10% of the approved loan amount into the Account, and 3) an additional 0.25% for depositing and maintaining a deposit balance of at least 20% of the approved loan amount into the Account.

Personal Line of Credit consists of a two-year, interest-only, revolving draw period followed by a fully amortizing repayment period of the remainder of the term. Draws are not permitted during the repayment period. Full terms of 7, 10 and 15 years available.

This product can only be used for personal, family or household purposes. It cannot be used for the following (among other prohibitions): to refinance or pay any First Republic loans or lines of credit, to purchase securities or investment products (including margin stock), for speculative purposes, for business or commercial uses, or for the direct payment of post-secondary educational expenses. This product cannot be used to pay off credit card debt at origination.

Personal Line of Credit minimum is $60,000; maximum is the lesser of $350,000 or debt to be repaid at origination plus $100,000. Line of credit cannot be fully drawn at origination.

The terms of this product may differ from terms of your current loan(s) that are being paid off, including but not limited to student loans. By repaying such loans, you may permanently be giving up tax and repayment benefits, including forbearance, deferment and forgiveness, and you may not be able to re-obtain such benefits if this loan is refinanced with another lender in the future.

Contact your legal, tax and financial advisors for advice on deciding whether this is the right product for you. Terms and conditions apply.

Product is not available in all markets. For a complete list of locations, visit firstrepublic.com/locations. Applicants must meet a First Republic banker to open account. This is not a commitment to lend; all lending is subject to First Republic’s underwriting standards. Applicants should discuss line of credit terms, conditions and account details with their banker.

The strategies mentioned in this article may have tax and legal consequences; therefore, you should consult your own attorneys and/or tax advisors to understand the tax and legal consequences of any strategies mentioned in this document.

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