Do personal loans affect my taxes?

You can use personal loans for various purposes, from consolidating debt or making home improvements to paying for a wedding. But before signing any paperwork, it’s wise to consider the potential tax implications of your loan. While a personal loan generally doesn’t affect taxes, defaulting on the loan can. 

Let’s dive into the basics of how personal loans interact with your income taxes so you have all the information you need before borrowing.

Do personal loans affect my taxes?

No, personal loans don’t directly affect your taxes. However, depending on how you use the loan and other factors, there may be indirect tax implications that you should consider before taking out a personal loan.

Under normal circumstances, a personal loan doesn’t count as taxable income because you have to repay it. However, if you default on the loan and the lender forgives $600 or more of your debt, that debt may be taxable as cancellation of debt income. The same is true if your debt is canceled or discharged for a lower amount. The IRS requires you to report canceled debt on your tax return for the year of the cancellation. 

WILL YOUR $10K-$20K OF STUDENT LOAN FORGIVENESS COME WITH A TAX HIT?

Is personal loan interest tax-deductible?

Generally, personal loan interest isn’t tax-deductible. However, there are exceptions to this rule.

Whether or not the interest you pay on your personal loan is tax-deductible depends on how you use the money. The interest isn’t tax-deductible if you use the loan to pay for personal expenses, such as a vacation, wedding or refinancing credit card debt.

However, if you use the loan proceeds for something that will generate income or for education, you may be able to deduct the interest:

• If you use the funds for business purposes, you can deduct the interest as a business expense.
• If you use the money to purchase an income-generating investment, you may be able to deduct the investment interest as an itemized deduction, subject to limits.
• If you use the funds for qualified education expenses for college, you may be able to deduct the interest. Qualified expenses include tuition and textbooks.

If one of these situations applies to you, it’s a good idea to discuss your situation with your accountant or tax preparer.

Note: Some personal loan lenders have restrictions on using the funds for education and business expenses. Be sure to check with the lender before accepting loan funds.

Types of personal loans

Since personal loans can be used for many purposes, you’ll often see different categories of personal loans, including:

Personal loans are usually unsecured, meaning they don’t require collateral. But in some cases, a personal loan may be secured with collateral. Let’s take a closer look at the differences between the two:

• Unsecured personal loans: This debt doesn’t require collateral — instead, a lender typically approves you based on your credit. These loans may have higher interest rates than secured loans since they’re more of a risk for the lender. But they often have lower interest rates than credit cards, and they can be a good option if you don’t have collateral to put up or if you need your loan funds within a week.
• Secured personal loans: This debt requires you to put up collateral to back the loan, such as your car or property. If you default on the loan, the lender has the right to take the collateral and sell it to pay your debt. Secured personal loans typically have lower interest rates than unsecured loans. But they also pose greater risk since you could lose your collateral if you fail to make payments.

You can easily compare personal loan rates from top lenders in minutes with Credible.

What are the requirements to get a personal loan?

Before applying for a personal loan, it’s a good idea to understand the general requirements you’ll need to meet. While eligibility requirements vary depending on the type of loan and lender, here are a few to consider:

• Credit: The lender will check your credit report and credit score to determine how much of a risk it is to lend to you. If your credit score is 670 or higher, you’ll have more loan options and qualify for lower interest rates. However, you can find personal loan lenders that specialize in lending to borrowers with poor credit.
• Income: Most lenders require proof of steady income before approving a loan application. Some lenders have minimum income requirements, while others only require you to show proof of income.
• Debt-to-income (DTI) ratio: Lenders will calculate your DTI ratio to determine whether you can afford the loan payments. They calculate your DTI by dividing your total monthly debt payments (including the loan you’re applying for) by your monthly gross income. If your DTI is below 36%, you’ll have an easier time qualifying for a personal loan. For example, if your monthly debt payments total $3,000 and your gross monthly income is $7,000, your DTI is 43% (3,000/7,000 = 0.428), which is on the higher side.
• Potentially collateral: If you have poor credit or need a large loan, the lender may require you to put up an asset as collateral, such as a car.

Depending on the lender, there may be other eligibility criteria, such as age or residence requirements. Be sure to check with the lender to ensure you meet all the necessary criteria before applying.

Personal loan FAQs

Here are the answers to some frequently asked questions about personal loans, to help you make an informed borrowing decision:

Will a personal loan affect my credit score?

A personal loan can have both a positive and negative impact on your credit score.

First and foremost, applying for a personal loan will cause a hard inquiry on your credit report when the lender checks your credit. This can cause a slight dip in your credit score, but this impact is brief (typically a few months if you only have one hard inquiry).

Ultimately, repaying the loan on time and in full will help raise your credit score over time, since it reflects a good payment history. However, missed or late payments can negatively impact your credit score, so it’s crucial to make all payments on time.

Am I required to report a personal loan when I do my taxes?

When you use a personal loan solely to cover personal expenses, such as a vacation or home repairs, you don’t have to report the loan on your tax return. If you use the loan for business or education expenses or for investment purposes, you may be able to claim a tax deduction. But you won’t have to report a personal loan in this situation either.

If you’re ready to get a personal loan, compare rates on Credible without affecting your credit.

Can I use a personal loan to pay my taxes?

Yes, you can use a personal loan to pay your taxes. However, there might be more cost-effective solutions. Before using a personal loan to pay tax debts, compare borrowing costs to setting up an installment plan with the IRS.