Pitfalls of Paying Taxes with a Credit Card
April 15th is quickly approaching, and while many consumers struggle to find ways to pay their income taxes, credit card issuers are encouraging people to use the convenience of paying with their card.
However, experts warn consumers to avoid paying their income taxes with a credit card.
Credit card payments of taxes are actually made to third-party providers, which are contracted by the Internal Revenue Service. Most processors charge a 2.49% fee for processing your credit card payment, making this an expensive convenience. Some, like FileYourTaxes.com, charge as much as 3.93%.
The 2.49% processing fee adds $199 to an $8,000 tax bill. If you don’t immediately pay off the credit card bill, interest charges add even more. For example, say you charge $8,000, your interest rate is 15% and you pay $400 per month—it will take 24 months to pay off the balance and you will pay an additional $1,333 in interest payments.
Along with this significant processing fee, consumers should also consider several other factors before using their credit card to pay their taxes:
* Check your credit limit. If you are anywhere close to your limit, this should not be an option for you. Issuers are now very sensitive about debt loads and customers who are close to their limit. This sends a warning to issuers that you are a risk for default, which could cause them to increase your interest rate. Other lenders may subsequently increase your rates.
* Verify that the tax payment will be treated as a purchase and not as a cash advance. Cash advances come with a high interest rate and typically a 3% cash advance fee.
* Be careful how you provide your credit card number. The IRS warns filers not to write the credit card number on the return and do not mail in the credit card.
* If you are considering a credit card payment because you don’t have money for your total payment, a better option may be an installment plan with the IRS or a loan from your bank or credit union. You will have to pay fees and interest, but the interest rate is probably lower than your credit card rate, and will not affect your debt utilization ratio.
* Obtaining reward points for using your credit card is not a good reason to charge your income taxes. The typical reward card offers 1% back for cash, points or miles.
Last year, some experts recommended the Citi CashReturns card, which offered 5% cash back for three months with no limit to the cash you could earn. Even with the 2.49% processing fee, it was a fairly good deal for paying your taxes. However, this year, that same card only offers 1% cash back, demonstrating how issuers have cut back on their rewards.
Experts say that instead of using credit cards to pay off taxes, consumers should use their tax refund to pay off their credit card bill. Paying down credit card debt improves your debt-to-credit-limit ratio, which improves your credit score, thus improving interest rates for other loans, leading to increased financial stability.