Is personal loan interest tax deductible?
January 24, 2023 5 min read
A personal loan can be used to consolidate debt, spruce up a home, cover unexpected medical bills or fund other big purchases. Generally, the size of a personal loan might stretch from hundreds to thousands of dollars with interest rates ranging from 10% to 28%, according to the Chamber of Commerce.
When it’s time to file your federal tax return, you usually can’t take a tax deduction for the interest paid on a personal loan during the most recent tax year. However, there are some exceptions. Learn more about what types of personal loan interest could be eligible for a tax write-off.
- A personal loan’s interest rate might vary based on factors like the loan applicant’s credit score.
- The amount paid in interest can be calculated using the loan amount, interest rate and payoff period.
- Interest paid on a personal loan typically isn’t tax deductible.
- If money from a personal loan goes toward certain business, college or investment expenses, the interest payments could be tax deductible.
An overview of personal loan interest
The interest rate for a personal loan is the price to borrow money. The rate depends on several factors—like the loan applicant’s credit score, income, debt-to-income ratio, amount of money they’re borrowing and length of the payoff period.
A free loan calculator can help a borrower understand how much they’ll have to pay monthly in interest for a loan.
For instance, a five-year $10,000 personal loan with an 8% interest rate might result in an estimated monthly payment of $203—for a total of $2,166 in interest paid during the loan period. But a $10,000 personal loan with a three-year payoff period and a 10% interest rate could result in an estimated monthly payment of $323 but only $1,616 in total interest.
Average personal loan interest rate
According to the Federal Reserve, the average interest rate for a two-year personal loan is 10.16%. But it’s worth noting that a personal loan’s interest rate can be impacted by the borrower’s credit score. A higher score may lead to a lower interest rate, while a lower score may lead to a higher interest rate or denial of an application.
Personal loans generally come with a fixed interest rate and fixed payoff period. Below are four personal loan scenarios.
|Loan amount||Interest rate||Payoff period (years)||Estimated monthly payment||Total interest paid|
What happens if the borrower ends up with extra cash and wants to pay off a personal loan early? Sure, they could save money on interest. But it’s also worth considering how paying off a personal loan early may affect credit.
When can interest on a personal loan be deducted from taxable income?
While the IRS offers tax deductions for interest on debt like student loans and mortgages, personal loans typically don’t fall into the same bucket. However, interest paid on a personal loan can be deducted from taxable income when the loan funds things like:
- Business expenses
- Education expenses
- Qualified investments
Whether the borrower is a small-business owner or has their own side gig, they might have to spend money to earn money. And according to the IRS, “You can generally deduct as a business expense some or all interest you pay or accrue during the tax year on debts related to your business.” In this case, if a personal loan is used to cover business costs, the interest might be eligible for a tax deduction. Qualifying business expenses may include:
- Transportation and vehicle costs
- Office rent and equipment
- Supplies and machinery
If interest payments do qualify as a business expense, the interest amount would be subtracted from the business income on a federal tax return. As a result, the borrower’s tax liability might decrease for the tax year when the interest was paid.
Keep in mind that if the proceeds of a personal loan are put toward both business and personal expenses, only the percentage of interest tied to the business expenses can be written off.
If all the money from a personal loan goes toward qualified education expenses for higher education, the IRS may view it as a student loan. Educational expenses may include:
- Room and board
- Supplies and equipment
The maximum annual deduction for student loan interest is $2,500. The student must be the taxpayer, their spouse or their dependent and enrolled at least part time. To receive the deduction, a single filer’s modified adjusted gross income (MAGI) must be $85,000 or less. If married and filing jointly, MAGI must be $170,000 or less. The deduction isn’t available if the student and their spouse file tax returns separately instead of jointly.
Keep in mind that many lenders won’t allow the proceeds of a personal loan to cover education expenses. And most personal loans come with higher interest rates than federal student loans do.
If money from a personal loan is used for certain investments, interest paid on the loan might be eligible for a deduction. The deduction can be taken only for taxable investments, including some:
- Mutual funds
The borrower can’t take an interest deduction related to investments that provide tax advantages, such as tax-exempt bonds. And an interest deduction can only be claimed for the percentage of a personal loan that went toward a qualified investment. And there’s another wrinkle—in order to claim this type of deduction, deductions must be itemized on the tax return.
Is interest paid on other debts tax deductible?
Deducting personal loan interest in a nutshell
Before taking out a personal loan, it might be helpful to consider whether you can write off the interest paid on that loan. In most cases, personal loan interest doesn’t qualify for a tax write-off. But if the money borrowed goes toward certain business, college and investment expenses, you may qualify for a tax deduction tied to the interest payments.