Should you use home equity to pay a tax bill? Experts weigh in

Tax debt can be a stressful financial burden to carry, especially if you're having a hard time paying what you owe in full. While you can use personal loans and credit cards to pay down smaller tax debts, these borrowing tools may not be the best solution if you owe tens of thousands of dollars given their relatively low borrowing limits and higher rates. So, if you're staring at a considerable tax debt and want to pay it off, what options do you have? 

The IRS Fresh Start program offers several options to help resolve your tax debt, including payment plans and settlement programs, but you still have to qualify for them. But if you're a homeowner, home equity lines of credit (HELOCs) and home equity loans generally have higher limits and lower average rates than personal loans and credit cards, making them a more affordable option for paying down a big tax bill.

But is it a good idea to tap your home equity to pay off your tax bill? Here's what the experts say. 

See how affordable your home equity borrowing options could be.

Should you use home equity to pay a tax bill?

Using home equity to pay off your taxes can make sense for some taxpayers, says Brian Seymour II, a certified financial planner (CFP) and CEO of investment adviser firm Prosperitage Wealth. Those who can't get a reasonable payment plan through an IRS installment agreement or don't qualify for IRS tax forgiveness may be a good fit to use their home equity to pay off their tax bill, Seymour says. In these cases, a home equity loan or HELOC may be the most affordable way to tackle what's owed in a timely manner, minimizing the possibility of facing serious repercussions stemming from unpaid tax debt.

Borrowing from your home equity could also make sense if your tax debt is in the $25,000 to $50,000 range, according to Seymour. "In these ranges, the IRS will likely file a Notice of Federal Tax Lien, their installment plans get more restrictive and the compounding interest and penalties start to become unbearable," Seymour says. So, finding an alternative solution, one that's still affordable, like a home equity loan or HELOC, could make sense.

Using a HELOC or home equity loan to cover a tax bill may also be a good option for taxpayers who have their finances in solid shape and have a considerable amount of equity in their home, says Marcus Sturdivant, Sr., managing member of The ABC Squared, a financial planning firm.

"If you have a lot of equity, this may be a good person to leverage their home to pay a tax bill, based on the assumption that this person has a history of payment on time, good debt-to-credit ratio, savings on hand, and a means to earn income, be it fixed income in retirement, wages from employment, or a mix of passive and active income streams," Sturdivant says.

Taxpayers whose finances are in order will typically be more likely to have the means to repay the home equity loan or HELOC on time, removing some of the risk that comes with leveraging your home's equity. Plus, a borrower with a good credit score, a solid income and other positive financial indicators may be more likely to get a good rate on a home equity loan or HELOC, ensuring that this type of borrowing remains the more affordable option.

Find out the home equity borrowing rates you could qualify for now.

When you should avoid using home equity to pay off a tax bill

Using your home equity to pay your tax bill may not be a good idea if you have issues controlling your spending, says Filip Telibasa, a certified financial planner (CFP) and owner of flat-fee comprehensive financial planning firm Benzina Wealth.

"Setting up the HELOC opens us up to the risk of using more of the home's equity for other expenses since it is available," Telibasa says. 

Using home equity to pay tax debt can be risky in several other key situations, too. If you're experiencing financial instability or inconsistent income, for example, tapping your home equity puts your primary residence at risk of foreclosure should you default on the loan. Unlike tax debt, which can potentially be negotiated with the IRS, home equity loans offer no flexibility once established.

You should also typically avoid using home equity when you qualify for more favorable IRS resolution options. The IRS offers payment plans with interest rates that are typically lower than home equity loans, and programs like Offer in Compromise might allow you to settle for less than the full amount owed. 

If your home is your only significant asset, using its equity eliminates your financial cushion for emergencies — so it may be worth thinking twice in these situations, too. Before making this decision, it may help to consult with a tax professional who can evaluate less risky alternatives that protect your primary residence.

The bottom line

Before deciding to use home equity to pay your tax bill, carefully weigh the pros and cons based on your unique financial situation. While home equity loans and HELOCs can offer lower interest rates and higher borrowing limits compared to personal loans or credit cards, they put your home at risk if you can't make the payments. There are certain times when that risk may be worth the reward, but you should still consider consulting with a tax professional to explore all available options, including IRS payment plans and settlement programs that might be less risky alternatives.