You don’t have much choice when it comes to paying taxes. However, you do have options on how to pay them. Writing a check is certainly one way, but in some cases, it may not be the best financial strategy. You may be in a situation where borrowing the money may be a better choice.
“Looking at all of the potential options can help you achieve your goals,” says David Mook, chief private banking officer at U.S. Bank Wealth Management. “This can be the case if you have an unusually high tax liability due to a large taxable event, such as selling a company or an asset that incurs capital gains, or if you just pay a lot in taxes every year. The government mandates when taxes are due, but that date may not make financial sense for you. Using credit can give you flexibility and control over when to liquidate an asset or come up with the cash.”
If you’re willing to consider debt to pay your taxes, here are three types of loans you could use to pay taxes.
1. Home equity loan to pay taxes
If you own a home or vacation property, you can tap into its equity by taking out a loan or line of credit to pay taxes.
One drawback is that this type of loan can take some time to set up, since the bank will need to appraise your home and prepare title work. You may also be charged upfront costs that could include an appraisal fee, credit report fee and loan origination fee. And rates may be higher than some of your other options.
After weighing the pros and cons, Mook says home equity loans may be a good choice for some people. “Most people are very comfortable having debt on their house,” he says. “Just about everybody has or has had a mortgage. This may be a more comfortable choice than other options.”
2. Personal loan to pay taxes
If you don’t want to put your home up as collateral, another option is a personal loan to pay taxes. The advantage to this type of financing is timing. Personal loans are generally faster to secure than a home equity loan.
Unsecured personal loans tend to be the most expensive way to borrow, however. Since you're not giving the bank any collateral, the loan will usually carry a higher interest rate. Personal loans may also have more restrictions, such as a shorter repayment term or smaller credit limit.
“Personal loans also require detailed financial disclosure, such as personal financial statements and past tax returns,” says Mook. “The underwriting process is a little bit more in depth for unsecured loans.”
3. Liquid asset secured financing loan to pay taxes
A third option to pay taxes is liquid asset secured financing, which involves pledging your portfolio of marketable securities to secure a line of credit. The amount you can secure is limited to the amount your portfolio can support. There are no costs or fees for setting up a line of credit, and this type of credit also has no required principal payments. Borrowers are only required to pay the monthly interest charge.
“This is the most inexpensive way to borrow, because interest rates are low,” says Mook. “You can borrow money and pay it back pretty much whenever you want. If you borrow $50,000, for example, you’ll only pay the interest on the $50,000 as long as it's outstanding. You don't have to pay the $50,000 back until you’re ready, assuming there's not a drop in the market that causes a margin call.”
Financing your tax bill could help you avoid creating another taxable event, like the capital gains you incur when selling a marketable security that has appreciated in value. Your portfolio may also grow at a faster rate than the interest you’ll be charged, making the cost of interest a more attractive alternative.
“The government mandates when taxes are due, but that date may not make financial sense for you. Using credit can give you flexibility and control over when to liquidate an asset or come up with the cash.”
Liquid asset secured financing is also the fastest form of credit. A line can be put in place in a matter of days. “We tell people to get them set up well ahead of time, because then it's a phone call to borrow money and you can have money the same day,” says Mook.
The drawback for this type of loan is that it’s tied to the market, which is unpredictable. If the value of the securities used as collateral falls below a certain threshold, you may need to pledge additional securities or pay down the loan. Otherwise, the lender could sell some or all of the securities.
Prepare for Tax Day by consulting with your tax advisor and financial professional to understand your tax liability and risks and to make plans for meeting them in a way that best fits your financial goals. Borrowing money is just one financial tool for paying your taxes, and ultimately the decision is up to you. Using one of these three types of loans to pay off taxes may make sense for you this year, or someday down the road.
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