Millions of Indians often end up in situations when their tax debts outstrip the money available at their disposal. When all other financial avenues close up, taking a personal loan to pay off tax debt could be a good option. Listed below are some of the advantages of availing a personal loan to pay off outstanding tax debt:

Saves you from penalties

Apart from a tax lien, tax authorities can also freeze bank accounts, attach property, or impose other heavy penalties and cumulative interests in case of failure to pay taxes. Taking a personal loan is a fairly easy and hassle-free way to settle outstanding taxes, as authorities can accept the full payment and halt proposed tax liens.

As a result, you are saved from being subject to heavy penalties and you also stay protected from tax liens.

This is important because tax liens can blight credit scores and hamper the ability to secure loans/credit in future.

Credit score benefits

Taking a personal loan is possible even for individuals who do not have very high credit scores. Further, securing a personal loan to pay off outstanding tax debt may actually help boost one’s credit score.

Helps preserve important funds

Those who do not have enough money to pay tax debts may consider dipping into their retirement corpus, home equity, emergency fund, or investments made for specific important financial goals. However, this is not advisable – there may be tax implications for borrowing against retirement accounts or investments, and tapping into home equity has other financial repercussions in case of a default on the loan. Also, the core objective of these funds is to come of use in the future when income sources start to dwindle, making it vital to preserve them for use towards the intended purposes.

Better interest rates, more consistent

It is always better to take a personal loan to settle outstanding taxes rather than paying it off using your credit card. Personal loans carry relatively lower interest rates compared to the high interest rates charged on credit card outstanding dues – While personal loans carry interest rates of anywhere between 11.5% and 24%, the interest rate on credit card outstanding could go up to a whopping 45%. In addition, credit cards have unpredictable monthly payment amounts, whereas personal loans involve consistent monthly payments in the form of EMIs.

Greater flexibility

Personal loans offer you the flexibility of fixing the loan tenure in sync with your repayment capacity. You can repay your personal loan over a period of time, with tenures ranging between one to five years. This flexibility allows you to plan repayment at the pace, time, and amount (EMI) most comfortable to you.

It is however important to note that the chosen loan tenure is a major determinant of your EMI. While a longer tenure translates to a smaller EMI, it also means higher interest cost. On the contrary, in case of a shorter tenure, the reverse is true. It therefore makes sense to opt for a shorter tenure – provided your repayment capacity and expected cash flows in future permit the same.

Limitations

  • Many banks do not permit personal loan prepayment before a pre-specified period is completed. Also, some banks levy prepayment charges, ranging from 2-5% of the outstanding principal. It is better to secure a personal loan that does not carry any prepayment penalty, particularly if you are expecting future inflow of a substantial amount.
  • Personal loans permit a limited amount of money, which does not serve the purpose in case the tax debt is massive.

Concluding

A personal loan allows you to pay off your tax debt immediately, in one go, saving you from paying piling up interests and other charges. Also, being an unsecured loan, a personal loan is less risky than, for instance, mortgaging your home or gold jewellery or using your credit card to pay off your tax debts.

After a careful analysis of all the pros and cons, if you still decide to go ahead and take a personal loan to settle your outstanding taxes, it is important that you:

  • Avail the loan from an established, well-known bank or NBFC
  • Compare all options available
  • Assess the interest rates (even minor interest rate differences can lead to a sizeable difference in your EMIs), and
  • Try getting the best overall terms and conditions

It is best to analyse your financial situation to assess how viable it would be to take a personal loan to clear your tax debts. If taking a personal loan to pay your tax debt works out to be your best option, it is best not to delay – passing time only means you end up paying more taxes as authorities have rights to impose steeper penalties on delinquent debts. The final objective should be to come out of the debt web completely, rather than getting pulled further into it.

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