5 Questions to Ask Before You Use a HELOC to Pay Your Taxes
A lot of people think of a tax return as free money. It's not. A tax return represents the amount of money you lent to the government this year, without charging them interest. But come April 17, if you didn't have extra money taken out of your salary or fees to cover taxes, you owe them. And if they lend you money because you can't pay? You pay interest. Doesn't sound fair, does it? But that's the way it is.
Tax season is always a little stressful--all that paperwork and dealing with a clunky online interface, or a less-than-friendly accountant. But don't wait til the last minute: Find out how much you owe now, so you have time to make some choices in case it's more than you anticipated.
If you owe taxes and have to borrow from the IRS by setting up a payment plan with them, you'll pay interest on the loan, but also penalties for late payment of your taxes. After all, the IRS is not your friend. They're fair, but they aren't in it to help you save money.
There's a better way.
Learn more → How Does the IRS Calculate Penalties and Interest?
With low-interest rates, a home equity line of credit (HELOC) may be the best way to pay your tax bill if you don't have the cash on hand.
If you have equity in your home, and a HELOC would cover your tax bill this year, it's worth considering. Here are some things to think about before you call your mortgage lender or banker.
- Do you have enough equity in your home to spare? Lenders are a little stricter these days about how much of the value of your home they'll let you borrow against. If you put down a larger down payment, or you've been paying your mortgage for a while, you probably have a decent amount of equity. But look before you leap because a HELOC is a secured loan, which means the lender could take your house if you don't pay.
- What kind of interest rate will you qualify for? Have you checked your credit score recently? How's your history with your bank? Make sure you get the best interest rate possible for your situation.
- But are you prepared for the variable interest rate of a HELOC? The rate won't be static. It can change from month to month. Make sure you're prepared to pay more per month if your rate goes up, because a HELOC is like adding to your mortgage, and your goal is usually to pay that down over the years.
- Do you like tax deductions? If you're borrowing under $100,000 on a HELOC, you can deduct the interest on your debt. The IRS won't let you do that, and neither will a credit card.
- Will you be tempted to overspend? A HELOC isn't free money, and it is a line of credit, like a credit card. You may not need to max it out to pay your tax bill, but will you be tempted to use it for other things? Why not save towards next year's bill instead?
A HELOC could be the best way to pay a surprise tax bill. Just use it responsibly. And if you want to avoid that bill next year, have more money withheld or, if you're self-employed, make sure you're paying the right amount of quarterly estimated taxes.
And whatever you do, make sure you get your taxes finished in time to avoid penalties!