Read about all the best practices for making loans with your friends, family, and the people you trust. Also, learn how to best navigate Pigeon Loans.

Loan Tips And Tricks | Pigeon Loans

Just about everyone has found themselves in a tight spot financially at some point or another. In these situations, you can't always be picky about where to get the cash you need.

But if you're considering a payday loan to cover your short-term expenses, you might want to consider other options. Here's why payday loans often do more harm than good — and what options you should look at instead.

A payday loan is a short-term loan with an often exorbitantly high-interest rate that’s often marketed to borrowers who don’t have enough money for an expense or need to borrow a small amount of money to tide them over before “payday” comes.

Payday loans are available both online and in person. To qualify for a payday loan, borrowers typically need to provide a pay stub or proof of income, legal identification, and checking or savings account information. 

Although they are high-cost loans, payday loans are popular because most do not require a credit check from one of the three credit bureaus or a look into your credit history. A payday loan amount is usually dispersed within a day after being approved. Naturally, this can sound very attractive, especially to people with lower credit who need quick cash, but taking out a payday loan can be a very dangerous financial decision. Each state has its own rules on how much you can borrow and in some states payday loans are flat out illegal - the limits for payday loans usually range between $50 to $1,000. 

According to a report from the Consumer Financial Protection Bureau (CFPB), more than 80% of payday loans are rolled over. When you roll over a payday loan into the next payday loan, the amount you accumulated in interest or loan fees is added to the principal, and in some states, you may even get charged late fees. The average consumer pays $250 in fees to take out a $375 loan (that’s a total of $625, almost twice as much as the loan itself).

Payday loan lenders charge the highest interest rates among all consumer lending products, some may argue, criminally high. The typical payday loan has an interest rate of 400% APR, while a credit card has an average annual percentage rate (APR) of 18%. In only a month, borrowing  $1,000 from a payday loan service would cost you $328.77 in interest - causing you to pay back almost 1/3 of the money you desperately needed in the first place.

Payday loans have a short repayment window, usually between two and four weeks. Most people can’t afford to repay a loan within that window or by their next paycheck, which forces them to renew their loan in order to stay afloat—thereby getting stuck in a cycle of debt. 

When you renew a payday loan, any unpaid interest is added to the principal. That means people in financial need in this situation end up being charged interest on a higher loan amount than before, making it even harder to pay off the balance!

Why You Should Be Cautious of Payday Loans Plus: Payday Loan Alternatives - Grid view

So if we take a step back and consider all of these facts, should we ask ourselves “are payday loans bad”?

Payday lending is supposed to help borrowers fix their financial problems in the short term, but it often has the opposite effect in the long term. Most people who take out payday loans can’t afford them, leading to a vicious cycle of inescapable debt. In fact, research shows that the average payday loan amount is 36% of the borrower’s income, but that the average borrower can only afford to repay 5% of their income. 

Just like it sounds, a payday alternative loan (PAL) is a similar product to a payday loan. The main difference is that it offers a lower interest rate. The maximum interest rate for a PAL is 28% APR, and the loan amount ranges from $200 to $1,000. 

The specific repayment term depends on the bank but generally ranges from one to six months. Because the rates are lower and the terms are longer, borrowers end up paying less interest with a PAL than a regular payday loan.

Only federal credit unions offer PALs. You can find a list of these credit unions here. To be eligible for a PAL, you must be a federal credit union member for at least a month to qualify for a PAL through them (although some credit unions may have longer requirements). 

A credit card can be a fast and easy way to access money when you need it quickly. The interest rates on a credit card can be higher than a personal loan (typically between 15% and 22%), but generally lower than a payday loan or PAL. 

If you have a credit score of 670 or higher, you may even qualify for a 0% interest rate promo offer on a credit card. These promotional offers usually last between six and 24 months. You can charge purchases to the card, only make the minimum monthly payment and not owe any interest. If you can pay off the balance before the promotional offer expires, then you won't have paid any interest at all 😉.

If you can’t qualify for a 0% interest rate, you can still use a credit card for emergencies. Always pay off your statement balance in full, otherwise, you’ll be charged interest on the remaining balance. While the interest charges on a credit card could be higher than a personal loan, they’ll still be lower than what you would owe with a payday loan.

When you take out a personal loan, the bank deposits the amount you borrow as a lump sum into your bank account. You can use the funds for almost any purpose, like rent, other debts, or medical bills, which is one of the many benefits of obtaining a personal loan. 

Unlike payday loans, personal loans have long repayment terms, usually between one to seven years. Personal loan amounts range from $1,000 to $100,000 — much higher than a payday loan.

Interest rates for personal loans range from 4% to 36% APR, depending on your credit score, the loan amount and the repayment term. If you have bad credit or poor credit, you likely won’t be eligible. You typically need a credit score of 600 or higher and a solid credit report to qualify for a personal loan, and if you do qualify for one, the interest on your personal loan may even be tax-deductible. 

If you have a credit card, you can withdraw cash from it by taking a cash advance loan. You can use those funds to cover an emergency or to pay your bills. Be careful though! Credit card companies charge a higher APR for a cash advance than for a regular credit card purchase, so you should only use it if you specifically need cash. 

For example, if you need to pay rent, your landlord likely doesn’t accept a credit card. Instead, you could take a cash advance and use those funds to cover the expense. The cash advance limit is usually between 30% and 50% of the total credit card limit. For example, if your credit limit is $10,000, then your cash advance limit may be between $3,000 and $5,000. 

Borrowing from a friend or family member may be a less expensive option than a payday loan, personal loan, or credit card. The person lending you money may choose not to charge you any interest, although we recommend you should always charge some nominal interest rate in order to avoid unintended tax consequences. 

Borrowing from friends or family is usually more flexible than any other type of loan. You can pick a repayment plan timeline that fits your budget, and it’s usually easier to skip a loan payment to a loved one—if absolutely necessary—than to a lender.

The downside of this approach is that a loan with a friend or family member could impact your relationship if you don’t pay off the loan as quickly as you promised. The person whom you are borrowing from may feel pressured to give you money because of your personal relationship, even if it interferes with their own financial goals. Regardless of these potential pitfalls, there are helpful services like Pigeon Loans out there to help you keep your relationship top of mind, and avoid any unnecessary pressures when dealing with this type of transaction.

Take a step back and consider these things the next time you consider a payday loan:

Look at lower-cost options, payday loan alternatives like - PALs, Credit Cards, or Personal Loans. 

Be smart and calculate any interest you may be paying before making a decision on a new loan.

Consider borrowing from friends and family if that’s an option.

Payday loans are arguably the most expensive lending option available and it can take months to repay these kinds of loans. Take the time to utilize better alternatives, and you may end up much happier with your decision!

Want to read more related content? Check out some more of our awesome educational pieces below:

The Top Benefits of Obtaining a Personal Loan

Lending Money? Borrowing Money? Avoid Tax Pitfalls

Balance Transfers vs Personal Loans: Here Is The Difference

Payday loans are often not a smart choice for any kind of borrower. They are riddled with high fees, predatory lending practices, and are not a recommended financial instrument to help yourself get out of debt. Explore some of the better alternatives to obtaining a payday loan.

Why You Should Be Cautious of Payday Loans Plus: Payday Loan Alternatives

If you are in the United States, obtaining a personal loan affects your credit score in several ways, both positively and negatively. How you are impacted primarily depends on two factors. 

The scoring models used by FICO and credit bureaus (Experian, Equifax, TransUnion) to calculate your credit score.

The way you use your personal loan funds.

Personal loans are a great way to get some quick cash, and can even be used as a debt consolidation tool. Used the right way, personal loans can improve your credit score. If you make timely payments and build a reliable payment history, you’ll likely improve your credit report and thus increase your credit score over time.

One of the best ways to build a great credit score is to pay balances on time and consistently. In fact, Experian tells us it’s better to make smaller payments more often than large payments less often. Therefore, if you’re paying off a personal loan in a consistent and timely manner, it’s certain to improve your credit score over time.

However, if you are not careful, obtaining a personal loan can hurt your credit score. For instance, if you already have a mountain of debt, and you apply for a personal loan, you’ll increase your amounts owed (i.e., your total debt), which could hurt your credit score. Plus, with more debt, lenders will perceive your future loan applications as high risk and charge a higher interest rate, or reject your loan application altogether.

All things considered if you're finding it tough to get a loan from a bank or credit union, getting a personal loan from your loved ones can be a smart move. Although you may not be able to boost your credit score if the loan is coming from your best friend or brother, personal loans from people you trust are often a lot more flexible and can help you in a time crunch. Regardless of their effect on your credit score, you have many great options for securing your financial future by obtaining a personal loan.

Can A Personal Loan Hurt Your Credit Score?

Getting a personal loan when you're already under a lot of financial stress can often spell bad news for your credit score. For instance, say there’s an attractive discount available on a car you’ve been wanting to buy. However, the discounted price is outside of your budget. You consider getting a car loan to make the most of the discount, but since you don’t qualify for one, you apply for a personal loan. You buy the car, but when it's time to make payments, you feel stressed. You miss payments and hurt your credit score.

This is why it’s important to know how personal loans can hurt your credit score. Assuming your lender reports your personal loan to a credit rating agency (not all lenders do), several things during the application process and after you’ve secured the loan can put a dent in your credit report. Did you know that simply applying for a personal loan can also affect your credit score?

A hard inquiry occurs when you apply for new credit and a lender subsequently pulls your credit report at the time of assessing your creditworthiness via a loan application. In order to offer you the best personal loans, lenders look at your credit history to gauge your creditworthiness. Based on their assessment and your length of credit history, they’ll decide whether to lend you money and on what terms.

Hard inquiries typically stay on your credit report for up to two years, and during that time they will appear as a negative mark on your credit history. The extent of a hard inquiry’s impact depends on the applicant's financial position. Typically, a hard inquiry will result in a drop of five or fewer points. But if you have a strong credit history, the drop in scores may be smaller.

Too many hard inquiries in a short period of time can lead to poor scores when undergoing a credit check, this reality may yield a decrease in the loan amount you are looking for, and ultimately will convey to your lenders that you may be facing insurmountable financial challenges in your personal finance journey. 

This may seem like a sticky situation if you hope to go apply with several lenders looking for the best rate. But the good thing is, you can check your credit score before you apply for a personal loan by undergoing a soft inquiry and no damage will be done to your score unlike the consequences of a hard inquiry.

Your payment history is the most important factor impacting your credit score. Positive payment history and even negative payment history account for 35% of your FICO score. So when bureaus like Transunion, Experian, and Equifax calculate your credit score, they are focusing mainly on long-term payment history, rarely short-term. 

💡 Consistently making all the payments for an entire loan term is key to building a good credit score. 

Ideally, you should make your personal loan payments as they become due. While missing payments isn’t good, a one-off instance isn’t the end of the world. Your lender will typically charge you a late fee for the missed payment, and potentially a higher APR (interest on your loan), but a late or missed payment typically won't end up on your credit report if you pay off any amount due within 30 days after you missed a payment.

If however, you miss payments, usually monthly payments, beyond the 30-day mark, you could incur severe consequences. If a late payment makes it to your credit report, it may stay there for up to seven years! So bottom line - don't miss payments when paying off a personal loan.

Can A Personal Loan Improve Your Credit Score?

Yes, a personal loan can help you improve your credit score. Whether or not a personal loan does improve your credit score ultimately boils down to you being a smart borrower who can manage your finances well.

Personal finance in regards to these types of loans is a tricky topic that many people struggle with, but luckily there are some tried and true tips you can implement to increase your chances of boosting your credit score. If you're hoping to use your next personal loan as a tool to improve bad credit, you should know about the following factors that can positively influence your credit score.

Quite intuitively, you can use your personal loan to improve your credit score by making timely payments. Making timely personal loan payments helps you build credit and demonstrates to lenders that you are financially responsible enough to manage additional lines of credit. Research suggests that people who have a strong track record of making on-time payments tend to be more likely to pay their debts in full. 

As you can imagine, getting paid back is the most important thing for lenders; this is why timely payments carry a significant amount of weight on your FICO score. So no matter how large your student loan payments are, make sure you pay them off every month 😉.

If you didn’t know already, credit mix, i.e., the types of active credit accounts you have, is an important factor that influences your credit score. Your credit mix can include mortgages, credit cards, and yes, even personal loans. If we dig a little deeper, we should also note that credit can be of two types—revolving credit and installment credit. 

Revolving credit is a borrowing agreement that allows you to take money out or put it back into the account as often as you want, provided you don't exceed your credit limit. Ring a bell? This is how your credit cards and related lines of credit work. 

Installment credit is a borrowing agreement that comes with a repayment schedule that tells you exactly when you need to make payments over a predefined loan term. The disbursements and withdrawals for an installment credit account tend to be less flexible than revolving credit accounts and may even include origination fees. Examples of installment loans include mortgages, car loans, and personal loans…you get the idea.

So, why does this matter for your credit score?

Well, diversifying your credit mix can help improve your credit score, especially if you only have revolving credit accounts like credit cards. The reason? Credit scoring models look favorably upon borrowers who can manage various types of credit accounts - so mix it up!

You can use a personal loan for pretty much anything, from rolling over student loans to consolidating high-interest debt in an effort to reduce your credit card balances, personal loans are a powerful tool you should use in your personal finance arsenal.  Not only do personal loans provide you with financial flexibility, but they also can positively impact your credit score if used responsibly.  

Whether you go to a bank, create a personal loan with a friend or family member, or even seek financial opportunities elsewhere, make sure you consider all of the ways you may impact your credit score. Just following a few of our best practices will have you well on your way to that 800 credit score you’ve been dreaming of!

What Types of Personal Loan Interest Are Tax Deductible?

How to Write Off Bad Debt For Unpaid Loans Friends Owe You

Balance Transfers vs Personal Loans: Here Is the Difference

Trying to build your credit score? Obtaining a small personal loan might be the best way forward for you to achieve your financial goals.

How Personal Loans Affect Your Credit Score

Got money drama? You’re not alone. The average American held $16,458 in personal loan debt in 2020. One way to tame your frustration is to write off bad debt for unpaid personal loans you might have doled out throughout the year.

If you meet certain criteria, you can reduce your taxes with a bad debt expense. What’s a bad debt expense, you ask? 👇

A bad debt is an unpaid loan you’ll never receive payment on. This expense can become a tax deduction in the right circumstances. Bad debt is sometimes called uncollectible debt, worthless debt, doubtful accounts, or uncollectible accounts.

And how can you use it to get a break on your tax return?

Can you write off bad debt on your personal taxes?

Long answer: According to the Internal Revenue Service (IRS), you can deduct an uncollectible debt (AKA bad debt) from your taxes if it meets certain criteria:

The loan recipient must be unable to repay the debt, and you have to prove it—often with documentation like a spreadsheet of payment history or financial statements (journal entries won’t cut it). Being unable to repay a personal loan means the borrower’s cash flow is lower than the amount of the loan.

Business-related loans do not count. A loan for the purposes of business expenses or to a business owner may potentially reduce your chances of receiving a write-off. Only nonbusiness loans count (a nonbusiness loan = a personal loan).

The IRS says, “Nonbusiness bad debts must be totally worthless to be deductible.” A worthless debt means one that was not paid back at all.

The loan cannot be a gift you provided with the understanding you may not get the money back.

You can only receive a deduction the year the debt becomes worthless (which may be on or before the loan’s due date, depending on the circumstances). 

For example, say the borrower fails to pay any part of a loan due June 2022 and doesn’t have the means to pay it back. Once the deadline hits, that loan is overdue and worthless. However, a borrower may file for bankruptcy in November 2021 without having paid anything on the loan, making that debt a worthless bad debt before the loan’s deadline.

How can bad debt get deducted as short-term capital losses?

If you deal with business taxes, you may know that you can use one of two methods to report a doubtful account (AKA a loan or invoice that may become a bad debt):

Direct write-off method: A business charges a bad debt as an expense as soon as it becomes clear no payments will be made.

Allowance method: A business estimates future bad debt at the start of any invoice and charges it to a reserve account.

For more information on the above terms, read about the direct write-off method here and the allowance method here.

However, people dealing with personal loans use a different technique. The IRS considers nonbusiness bad debt from personal loans a type of short-term capital loss. 

Typically, short-term capital losses refer to losses on investments held for a year or less 📉. But they also apply to bad debts on personal loans you made.

As of the 2021 tax year, the law on short-term capital losses states: You can use uncollectible accounts to subtract from capital gains, and any extra can be written off your taxable income by up to $3,000.

For example: Say you sold some stocks in 2021 and made $5,000 on top of your initial investments (congrats—that’s a capital gain!). Now, you’ll be subject to capital gains tax. Short-term capital losses let you subtract losses up to $3,000 from capital gains, meaning you’d only owe taxes on $2,000 of investment returns. 

Since bad debt on personal loans gets deducted as a short-term capital loss, you could reduce your capital gains taxes by deducting up to $3,000 from any earnings. If you didn’t sell any investments for a profit in 2021, the IRS lets you deduct up to $3,000 directly from your taxable income (which reduces the income taxes you have to pay).

Some personal loans are worth more than $3,000. Once you claim short-term capital losses up to the annual limit, you can roll over any extra value on an uncollectible debt. For example, say you made a personal loan worth $5,000. In this case, you can deduct up to $3,000 the year the debt becomes worthless and roll over the remaining $2,000 as a short-term capital loss the following year.

If you meet all of the criteria for writing off bad debt from a personal loan, you can report your short-term capital losses on IRS Form 8949.

You need a written loan agreement to prove your bad debt loss

Even personal loans require a bit of bookkeeping 🥵. Fortunately for you, it’s simple to keep track of personal loan matters.

In order to prove you made the loan with the intention of being repaid, you must present a written loan agreement signed by both parties. Technically, a handwritten agreement counts—but it’s always best to use a formal contract with clear terms (like Pigeon Loans, which we provide for people looking to lend money free of charge).

Bad debt deduction: More requirements for eligibility

It’s one thing if a person doesn’t want to pay you back. It’s different when they actually cannot afford to do so. The IRS only lets you deduct a bad debt from your taxes when there’s no way someone can pay you at all. For example, the borrower may have filed for bankruptcy or simply does not have enough money to pay you.

You also need to prove that you’ve made a genuine effort to collect the debt. Signing a loan agreement, sending payment reminders, and offering numerous ways to reclaim payment are just a few ways to show you’ve made a genuine effort to collect your debt (Pigeon Loans provides all these values for you). 

The IRS doesn’t require you to go to court to prove a debt is worthless if you can show it on your own 👌.

How to prove your loan recipient cannot pay the bad debt expense

You can prove your loan recipient can’t pay you back by showing bank statements or bankruptcy filings (if applicable).

You’ll also need to prove you’ve attempted collection numerous times by showing copies of letters and invoices you sent, plus records of any calls you made. There’s no set number of times you need to reach out to a friend or family member, but keeping a record of your attempts to reach out is key.

Step by step: How to perform a bad debt write-off for a personal loan

We're keeping it 💯. Here’s the checklist on bad debt you’ve been waiting for - take a screenshot, print it out, and check off the boxes as you complete these steps:

☐ Head to Form 8949 to record your bad debt expense on a personal loan you made. The bad debt write-off form is the same one you’ll use to record capital gains and losses. Financially savvy folks may already be familiar with this form.

☐ Part 1, Line 1: Enter the dollar value of the full loan amount you would like to use as a tax deduction. 

☐ Column A: Write the borrower’s name.

☐ Column D: Write the proceeds you received, which should be $0.

☐ Column E: Record the amount of money that you haven’t received repayment on. Since the IRS requires the loan to be fully worthless, this should be the same amount you wrote in Part 1, Line 1.

☐ Along with the form and your tax return, attach a personalized “bad-debt statement” that explains the doubtful account in full. This is where you can share documentation about the loan agreement, your contact efforts, and the borrower’s inability to pay. Providing screenshots, exported documentation, and emails courtesy of Pigeon Loans will make your case very strong.

Is it too late to take a bad debt deduction on your tax return? If you just realized you can get nonbusiness bad debts written off on your taxable income, know that you usually only have three years to amend a tax return 🤯. Check which tax year the loan became worthless to see if you can still claim a write-off for it.

Bottom line: Turn your bad debt loss into a gain

Next time you decide to lend money to a friend or family member, make sure you cover all your bases so you can claim a tax write-off if the borrower can’t pay you back. Getting a signed loan agreement, charging interest, and sending payment reminders is a good start.

We made Pigeon Loans to prepare for situations like this because no one wants to be left with bad debt or a strained friendship 🤝.

4 Tips To Successfully Navigating Loans with Friends & Family

If you lent out a loan that will never get repaid, you have options. Whether it be from family or friends, here’s how to write off bad debt to get a break on your tax return.

Did you know Americans held nearly $162 billion in personal loans by the end of 2020? That’s a lot of cold, hard, borrowed cash. And there are some great reasons for it.

Statistically speaking, if you were in a room with 12 friends and family members, one of you would be holding a personal loan for several thousands of dollars. If it’s you, then you may already know the benefits of personal loans. Carry on with your borrowing self.

Whether you are this loan holder or not (yet), you may want to stick around. We’re diving into some of the top advantages a personal loan offers over other borrowing methods so you can decide if it’s the right financial approach for you.

There are many, many benefits to getting a personal loan—we’re going to stick to just the top five for this article. 

The reasons borrowers typically choose personal loans over other types of loans (payday loans, home equity lines, credit cards, auto loans, and credit building loans) is because of the following benefits.

Personal loans offer quick access to cash

Borrowers face little to no restrictions on how they can use their loan

Personal loans usually don’t require collateral as a term for approval

Personal loans tend to offer lower interest rates

Borrowers appreciate manageable and predictable repayment terms

Let’s dive deeper into the benefits of personal loans. 

When you need cash in a hurry, a personal loan is a great borrowing option to consider. 

If you’re turning to a financial institution, you can be approved quickly (if you have a good credit score, you’re likely to be approved faster). Cash can land in your account within a matter of days. 

If you’re borrowing from friends or family, you could be just minutes away from the cash you need. There’s no quicker way to get money in a pinch - so, if time is of the essence for you, join our community & start creating the loan you need with your loved ones today.

Why this is a benefit: Life loves to throw curveballs at us mere mortals. When the furnace gives out in the middle of winter or the car ends up in the shop right before vacation, having a way to quickly access cash is important. 

👍 You Don't Have To Worry About Restrictions

Different loans are used for different things. Mortgage loans must be used to purchase a home. Car loans must be used to buy a vehicle. Funds from student loans must be used for tuition or other approved expenses. You get the idea.

But when it comes to personal loans, borrowers have more freedom on how the funds can be used. Outside of personal loans, a lender might ask you how you’re planning to use the money - restrictions are rarely part of the fine print. Some examples of how borrowers can use the funds from a personal loan include:

Covering unplanned expenses, like medical bills

Funding a family vacation or other large purchase

Collateral is any kind of asset you must temporarily exchange in order to get certain kinds of loans. Think a car or house title, jewelry, or even future paychecks.

Every lender sets their own terms and requirements for a personal loan, including whether or not they require collateral. While you may come across a lender that only offers secured loans or requires a cosigner, most personal loans are unsecured (especially for applicants with great credit). When reviewing a loan application, lenders usually consider a borrower’s:

As long as your credit report checks out, you likely won’t have to put down collateral for your personal loan. Collateral, schmollateral!

Why this is a benefit: When you’re facing an unforeseen financial emergency, having to risk assets to get much-needed cash adds to the stress of the situation and process. Just make sure your lender isn’t compensating an unsecured loan with sky-high interest rates.

Personal loans tend to offer lower interest rates, making them a great tool for consolidating credit card debt.

Let’s say you have three lines of credit. One has a credit card balance of $5,000, another has $3,000, and the last has $2,000. They each have different interest rates (comparable to national averages) and corresponding monthly payments, as shown below. 

The Top Benefits of Obtaining a Personal Loan (Table 1) - Credit Card Options

By making minimum payments for each credit card at once, it will take you 3 years to pay off all these debts and you’ll end up paying a total of $12,596 after interest.

But let’s say you take out a personal loan from an online lender today, get a lump sum of cash tomorrow, and pay all of the above balances in full by next week. Your debt would be consolidated into one personal loan of $10,000. 

Here’s what you could save, depending on your new interest rate.

Blog Article: The Top Benefits of Obtaining a Personal Loan (Table 2) - Personal Loan Options

Even at a 15% interest rate personal loan, which is obtainable even with average credit, you’re bringing down your monthly payment slightly from $348 with credit cards to $347. Although this may not be a big difference, the ultimate advantage lies in the fact that you’ll have all your debts paid off in the same 3 years of payments, and you’ll ultimately save just about $100 in interest. If you can secure a personal loan with a minimal interest rate of say 0.5%, like from a close family member, you’ll experience significantly greater monthly savings all while keeping over $2,500 in interest over the course of your loan.

Personal loans are a great debt consolidation option. You just have to know what benefits are most important to you.

Why this is a benefit: Saving money is always a benefit. As long as you avoid racking up additional debt and make all your payments on time, personal loans can help you save thousands of dollars in interest payments (depending on your personal debt scenario, of course) through debt consolidation. In many scenarios, personal loans can offer more than one money-saving benefit. But as a helpful tip, you’ll always want to crunch the numbers to make sure you’re saving and benefiting from debt consolidation through a personal loan.

👍 You Can Predict And Manage Your Repayment Schedule

Did you know that at the end of June 2021, the average American carried an unpaid balance of $6,569 on their credit cards?

One reason people sometimes skip their monthly credit card repayments is because the amount varies for each billing cycle. A sudden surge in spending or a hike in interest rates (most credit cards have variable rates) can raise a credit card’s monthly payment, making it more difficult to keep up with for some consumers. 

In contrast, the best personal loans have fixed monthly payments. Terms are simple to understand and there are no prepayment penalties to worry about. The only scenario that could raise your monthly payment is delinquency, which is why we always recommend using a personal loan calculator to make sure you can afford your loan payments before signing a contract.

Why this is a benefit: Knowing exactly how much to budget for your monthly loan repayment prevents delinquencies and financial stress.

Skip the drawn out applications, crazy collateral criteria, high interest rates, and hectic repayment schedules that other borrowing options can throw your way. Personal loans are an easier way to get the amount of money you need straight to your bank account.

If you’re looking for a safe and simple way for family and friends to loan each other money (and enjoy the benefits of personal loans), Pigeon Loans can help. Learn more about our loan process today.

Personal loans offer unique advantages over other borrowing methods.

Have you considered getting a personal loan and aren't sure yet whether it's the right choice for you? Compared to other alternatives, personal loans can save you time, money, and peace of mind. Understand the benefits of obtaining a personal loan before you make a decision on how to cover your financial needs.

A summer wedding. A fall vacation. A winter filled with gift exchanges and a few minor home improvement renovations. These are all valid reasons to take out a personal loan.

All of these seasonal scenarios are also followed by spring taxes...and likely plenty of questions. 

Is personal loan interest tax deductible? 

Do I include cash from a personal loan as part of my income?

How do I report a canceled personal loan?

Taxes can be, well...taxing—especially when you’re dealing with a new financial scenario, like a personal loan. Stay tuned as we learn more about personal loans and how they affect your taxes.

Can a Personal Loan Interest Deduction Be Claimed on Taxes?

In most cases, personal loan interest cannot be claimed on your taxes. But, there are exceptions that you may be able to take advantage of when taking out a loan for personal use.

You may be able to claim personal loan interest as a tax deduction if some or all of the interest can be linked to:

We’ll cover these exceptions more in just a bit. But first, let’s start by defining what it means to claim interest on your taxes. 

Meet James. James works hard. In fact, he made $75,000 last year before taxes (great job, James!).

Like all outstanding citizens, James is a taxpayer so James is getting ready to file his taxes for his latest tax year. He knows that the Internal Revenue Service calculates taxes as a percentage of his income. So he starts crunching the numbers based on his cool 75K. 

But wait, James! Don’t you know about deductions? A tax deduction is a reduction of taxable income. You can qualify for a dedication if you’re married, have children, make charitable donations, contribute to an IRA account, install energy efficient appliances, or even when shopping for clarinets (see for yourself). Another common standard deduction is interest paid on loans.

After James applies his deductions, his taxable income drops down to $55,000. And those income tax savings add up to a lot of extra clarinet lessons!

So, What Types of Personal Loan Interest are Tax Deductible?

Let’s get back to personal loans. Similar to mortgage loans, auto loans, and credit cards, personal loans often have an interest rate built into their repayment schedule. But typically, only mortgage interest qualifies for a tax deduction.

As a rule of thumb, interest paid on a car loan, home equity loans, credit card debt, or loans used for personal finance is not deductible. But before you file your tax return, make sure you don’t fall into any of the following three personal loan exceptions.

☑️ Using a Personal Loan for Business Purposes

Business loans aren’t always easy to get, especially if you’re self-employed. If you use any of your personal loan funds to form or run your small business, the associated paid interest can be deducted when you file your personal taxes. Website development, purchasing inventory, and marketing can all qualify as business expenses (FYI, if your small business files taxes, you cannot claim business expenses on both your personal AND business tax forms).

☑️ Using a Personal Loan for Qualified Higher Education Expenses

One in eight Americans have student loan debt. While these loans are one option for tackling the high cost of further education, funds from a personal loan can also be used to pay for college tuition, fees, and associated activity costs. This means that interest payments on a personal loan used to manage certain education expenses, including student loan interest, may be deductible.

☑️ Using a Personal Loan for Taxable Investments

If you use the money from your loan to invest in stocks, mutual funds, or bonds, you may be able to deduct any paid interest on your taxable investments. But keep in mind there may be tax implications in the form of short-term or long-term capital gains and you’ll need to itemize your deductions to take advantage of this deduction, which isn’t common.

Examples of Deducting Personal Loan Interest from Taxes

For the sake of seeing these exceptions in action, let’s check in with James. Did you know he took out a personal loan with a total loan amount of $10,000?

He used $2,000 to buy new equipment for his business. Then he spent $3,000 on his college tuition (business owner and student? Way to go, James!). Then he invested $1,000 in the stock market. He used the remaining $4,000 for personal expenses, specifically an incredible Caribbean vacation (James works hard and plays hard). 

Can James deduct any interest paid on this loan and receive tax benefits? Most likely, yes! 

He’ll want to work with a trusted tax professional to help him with the details, but he can likely deduct interest paid on the portions of the loan that paid for his business expenses and college tuition. He may be able to deduct the interest paid on the portion used to buy stocks, but this is trickier to accomplish since it has to be an itemized deduction. As for the part of the loan that fueled his getaway, because it’s a personal expense, he’ll have to settle for a tan instead of a deduction.

Are Personal Loans Considered Taxable Income?

We know what you’re thinking. If personal loans count as part of your taxable income, are you really saving anything by deducting the associated interest?

This could be a valid point—except personal loans are not considered taxable income. Taxable income is defined as money you earn after deductions from your adjusted gross income (AGI), primarily received through either  a job or investments. Because personal loans are funds received with an intent to pay back, they do not increase a borrower’s taxable income.

What Happens if Your Personal Loan is Canceled?

If you took out a personal loan and then defaulted on your payments, you’ll have to take a few extra steps come tax time. 

Depending on your lender, upon default, your lender will issue you a cancellation of debt, or COD. You’ll then receive a 1099-C tax form that will need to be submitted to the IRS with your return.

While a loan in good standing doesn’t count as taxable income, unpaid and canceled debt does. Here’s why. 

When you borrow a dollar, but give a dollar back, your bank account remains neutral (assuming there were no origination fees or a high amount of interest). But when you borrow a dollar and only pay back fifty cents, you’re essentially ahead by two quarters. Unlike personal loans in good standing, unreturned loans qualify as income in the eyes of the IRS, and are taxed accordingly.

Are you looking for more ways to claim tax deductions, tax credits, or other tax benefits? Did you know that interest from your personal loans may qualify you for tax savings? Learn about the ways you can use personal loan interest to your advantage on your taxes.

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