Whether you’re taking out your first loan or your fifth, it can be confusing to comprehend exactly what doing so means for you and your money. If you want a better grasp on the different loan types and taxes you may need to pay, check out this overview.
According to Jackie Veling, writing for NerdWallet, a personal loan is money that you borrow from a financial institution and must pay back over time in monthly installments. You may take out a personal loan for almost anything, including medical bills, a home improvement project, a wedding, or even a vacation.
Veling says the vast majority of these loans are unsecured, so they don’t rely on collateral. Lenders will look at your credit history, credit score, free cash flow, and more to determine if they will provide the money you need. If lenders offer a secured loan instead, you will need to back it with your home, car, or another asset. This means they can repossess your asset if you don’t stick to the terms of your agreement.
When it comes to tax time, you usually don’t have to list personal loans as income. Louis DeNicola of Experian notes that tax implications change if you receive a loan from a loved one or personal connection instead of a financial institution. “For example, if the loan has no interest or a below-market interest rate, as determined by the current ‘applicable federal rate,’ the IRS may consider it a gift rather than a loan,” he says. That change will have an effect on the taxes of the person who gave you the money, however, not you.
If you need to take out a loan when you purchase a house, Julia Kagan, a contributor to Investopedia, says this is called a mortgage. Once you have your eye on a property, you can apply for a mortgage, and a lender will then offer the loan amount and the interest rate you must pay.
According to Kagan, this interest rate will remain the same in a traditional or fixed-rate mortgage. However, in an adjustable-rate mortgage, it will be fixed only for the initial term and will later have the potential to change. The entire loan term will typically last for 15 years or 30 years, though it can also be far shorter or longer.
One of the most infamous tax advantages, if you have a mortgage, is the home mortgage interest deduction. In theory, this lets you deduct any interest you paid on your mortgage from your itemized taxes, according to Lisa Smith of Investopedia. However, the Tax Cuts and Jobs Act of 2017 changed the maximum mortgage principal from $1 million to $750,000, instead choosing to add deductions elsewhere and reducing the need for an itemized tax filing.
Laws and guidance around tax deductions for mortgages are constantly changing, so consider consulting a tax expert before filing with the IRS.
When you go to college, the U.S. Department of Education may offer a federal student loan, according to Federal Student Aid. In order to apply for one, you will need to submit a Free Application for Federal Student Aid form. If you’re an undergraduate student with a financial need, you may receive a direct subsidized loan.
Whether you’re an undergraduate or graduate student, Federal Student Aid notes that you may be able to get a direct unsubsidized loan, even without financial need. If you’re not eligible for either of the aforementioned loans, another option is to borrow money from a financial institution or other private sources.
If you’re a recent college graduate faced with paying off student loans, there is some good news for you. In specific circumstances, you can deduct up to $2,500 of what you, your spouse, or a dependent paid in student loan interest from your taxes as of the 2020 filing year. According to the IRS, a lot of the rules around this deduction are tied to adjusted gross income, so make sure that you meet all requirements before you add the interest to your taxes. You will also need Form 1098-E, the Student Loan Interest Statement, to file your return.
The type of loans you should take out and how they influence the amount you owe in taxes can vary greatly depending on your situation. Speak with an advisor to learn more about your personal finances.