Tax season can be a little stressful; you have to think about different documents and due dates. When finally submitted, you’ll have to wait for your tax return, which can take some time. When filing, you also have to make sure you remember a lot of financial information to get things right on your tax forms. Suppose you had any loan, such as a personal loan, for which you paid taxes in the past year. In that case, you might be curious whether loan interest is tax deductible.
There are some loans whose interests may be deductible while others are not. For example, student loan interest and mortgage interest are almost always tax-deductible, while personal loans can vary. Continue reading to learn more about loan interest rates and whether they can be deducted from your taxes.
General Information on Tax Deductions and Credit
There are some basics about tax benefits you should know about when trying to learn more about deducting loan interest. Here are some definitions:
Taxable income is pretty much exactly what it sounds like; it is the amount of your income that will be taxed by the federal government. Almost everyone has to pay some taxable income if they earn money. However, some kinds of earnings don’t have income tax tacked on to them—called tax-exempt income.
A Tax Deduction
A tax deduction decreases the amount of your taxable income and, therefore, the amount you owe. Tax deductions can be itemized, or you can take a fixed amount for a standard deduction.
A Tax Credit
A tax credit is money that you subtract from the taxes you owe. So, for example, if you owed 2,000 but had a 1,500 tax credit, then you would only owe $500. All kinds of tax credits are available to help people from all walks of life. For example, if you are a parent, a child tax credit can get up to $2,000 per child. A report from the Tax Foundation found 28.2 million filers claimed the federal child tax credit in 2017.1
Another example is for teachers who may have access to the educator expense deduction, which allows eligible teachers to deduct up to $300 or $600 if married, filing jointly, and both spouses are eligible educators (but not more than $300 each).
Understanding The Difference Between Tax Credits and Deductions
At this point, you may wonder: “Isn’t a tax deduction and a tax credit the same thing?” Well, they act similarly, but they are different! Tax deductions reduce the amount of your income that is taxed, which changes your tax calculation. In contrast, tax credits can reduce those calculations or, even better, increase the amount you get on your tax return.
For more information and details on tax deductions or credits, visit the Internal Revenue Service (IRS) website!
Are Personal Loans Tax Deductible?
If you also have a personal loan, you may be curious about whether the interest paid on these loans is tax deductible.
In general, the interest you pay on a personal loan when it is for most expenses or purchases is not eligible for tax deductions. However, there are exceptions.
Here are a few instances of personal loan uses where you may be able to deduct interest:
Personal Loans as Business Expenses
If the personal loan you take out is used for business expenses, any interest payments on the loan can be tax deductible. Keep in mind that you will have to prove that you used the personal loan funds on business-related expenses. Not sure about the benefits of using a personal loan over a business loan—learn more about business vs. personal loans.
What Qualifies as Educational Expenses
If you use your personal loan for education-related expenses, then the taxes from it can be deducted from your taxes. Educational expenses include tuition, room and board, transportation, books, technology costs, and more. Your loan servicer will provide a breakdown of your interest paid before tax season.
Personal Loans as Investments Income
If you used your personal loan to purchase taxable investment products such as bonds and stocks, then your personal loan’s interest rate can be deducted from your taxes. There are some investment types that don’t qualify for this tax deduction, and you may have to make a certain amount of investment income to qualify.
Loan Options Whose Interest Rates Are Tax Deductible
So, for the most part, personal loans, when taken out for personal use, their interest will not be tax deductible. However, if you do use your personal loan for business, educational, or investment purposes, then its interest can be tax deductible. Although personal loans aren’t usually going to fall under this category, there are other types of loans whose interest rates are almost always tax deductible. Here are some of those loan options:
Business Loan Options That Are Tax Deductible
Business loans are funding options that owners can use for almost any type of business expense. Some ordinary business expenses include payroll, employee health insurance, rent, utilities, equipment, and travel.
Business loans can be found at financial institutions such as banks and credit unions, but also with private lenders. There are several kinds of business loans out there. The most common are installment or term loans and qualifying lines of business credit—all of which have interest rates that are tax deductible. Business credit card debt can fall under this category and will determine the amount of deducted interest.
Student Loan Interest Deduction
Both federal and private student loan option interest rates can be deducted from your taxes. Some examples of student loan types include:
- Direct Subsidized Loans
- Direct Unsubsidized Loans
- Direct PLUS Loans
- Direct Consolidation Loans
- Sallie Mae Loans
- Ascent student loans
- College Ave student loans
You should usually get that tax information from your student loan servicer before or during tax season.
Mortgage Loans and Mortgage Interest
While a standard personal loan used for everyday expenses is usually not tax deductible, the interest you pay on a mortgage can be! Homeowners who finance their home through a mortgage loan and pay home mortgage interest may be able to take advantage of a tax-deductible interest. They can use the IRS form 8396 to claim a mortgage interest credit/mortgage interest deduction. If you are unsure about how much you paid on mortgage interest, you can look over your mortgage statement or talk to your lender.
Home Equity Loans or HELOC
One place that some people may get confused is when it comes to home equity loan interest and mortgage interest. A home equity loan can be borrowed against the value of a home.
Let’s say you are a homeowner and have a mortgage and decide to take out a home equity loan.
These will be looked at separately most of the time rather than together. In order to get the interest you pay deducted, you will need to invest in your house. For example, if you take out a home equity loan and use the funds to finance a car purchase, then the interest payments for that loan will not be deductible.
Investment Interest That Is Tax Deductible
Another type of interest that may be tax deductible is any investment interest. Keep in mind that not all investments are tax-deductible, and there are restrictions. Typical forms of investments can include things like:
To take the investment interest dedication, you will need itemized deductions.
Tips When Borrowing Loan Options
If you are thinking about a personal loan for a business, investment, educational, or any other personal expenses, you should pay attention to a few key things. Regardless if your loan will have tax-deductible interest. Here are some variables you should pay attention to to get the best experience and save money:
The Repayment Terms
The repayment terms of your loan can encompass a few different factors, including grace periods, fees, loan contract agreements, and avenues to repay your loan. Repayment terms are extremely important to pay attention to because they can determine how successful you are with a loan. By finding a loan that fits your repayment needs, you can rest assured that repaying the loan will be simple.
The Interest Rate and APR
A loan’s interest rate is the money you pay to your lender for borrowing the principal amount. While the APR or Annual Percentage Rate is the interest rate and other costs for the loan. Both costs are significant to consider when deciding between loan options. The higher your interest and APR, the more you will pay for your loan. Your credit score plays a significant role in determining your interest and APR.
The Loan Amount
The loan amount is another important factor of a loan to look into. You’ll want a loan that covers the full costs of your expenses, as juggling multiple loans can be tough and not the most financially sound choice. Keep in mind that you never have to borrow more money than you need, even if you are approved for additional funding.
The Lender You Are Working With
Although you may not think about the lender you are working with right away, chances are that when repayment begins, it will be something that greatly impacts your loan experience. Ideally, your lender will be flexible, transparent, give you the ability to repay your loan early, be helpful, attentive, and provide competitive terms and rates. Before you choose a lender to work with, read past customer reviews and experiences. Also, ensure that your lender protects your personal information, especially when working with an online lender.
Along with some of the details, remember that lenders operate differently. For example, financial institutions like banks and credit unions may have stricter eligibility requirements, shorter hours, and an in-person process. While online lenders may be more flexible with eligibility and application or funding hours.
A Word From CreditNinja
At CreditNinja, we understand the intricacies of finance and the importance of making informed decisions, especially when it comes to tax season. While loan interest deductibility might seem complex, it’s vital to grasp these nuances for a brighter financial future. If you’re ever in doubt about your financial choices or their tax implications, it’s always a good idea to seek professional guidance. And remember, when it comes to your financial journey, CreditNinja is here to help guide the way.