The tax deadline is less than a month away and consumers will soon be bombarded with messages encouraging them to pay their taxes with a credit card. While this may sound appealing to consumers who may be struggling to find ways to pay their taxes in this turbulent economy, it should be avoided at all costs.
The IRS and some credit card issuers both promote the benefits of paying taxes with a credit card. Payment with a credit card is easy and it can be made of the phone or online. It delays the pain of payment for another month. Consumers can even earn reward points on some cards with your tax payment.
But credit card payments of taxes are actually made to third-party providers which are contracted by the Internal Revenue Service. Processors charge anywhere from 1.95% (payUSAtax.com) to 3.93% (FileYourTaxes.com). Most third-party providers charge 2.45% fee for processing your credit card payment, making this a very costly convenience.
The 2.45% processing fee adds $122.50 to an $5,000 tax bill. If you don't immediately pay off the credit card bill, interest charges from your credit card will add even greater penalties. Since interest rates have increased significantly over the past year, this makes paying your taxes by credit card even more costly than last year.
Along with this significant processing fee and possible interest penalties, consumers should also consider other factors if they are considering using their credit card to pay their taxes:
* Know your credit limit before you charge your taxes. If you are anywhere close to your limit, this is not 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. If this payment puts you close to your credit limit, it can raise your credit utilization score, an important factor in your credit score. This can result in a lower credit score and higher interest rates from your lenders.
* Verify that the tax payment will be treated as a purchase and not 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 not to mail in the credit card.
* If you cannot afford to pay your taxes right now, there are less expensive options than a credit card loan. An installment plan with the IRS is one possibility; the interest rate is currently 4% percent for underpayments.
Another option is a personal loan with a bank or credit union. You may receive a lower interest rate, and that rate will likely be fixed, unlike the IRS interest rate and a credit card's interest rate, both of which may change.
* Obtaining reward points for using your credit card is not a good reason to charge your income taxes. Several years ago, generous credit card reward programs offered 3-5% cashback and some cardholders were able to make a little money by paying their taxes with a reward card. Since the typical reward card now offers 1% back for cash, points or miles, the 2.45% processing fee will cost more than the rewards you can earn. You are better off saving the money on the fee.
"Consumers should avoid using their credit card to pay their taxes. It is much smarter to use your tax refund to pay off your credit card balance.
Paying down your credit card debt will improve your debt utilization ratio, which helps your credit score, which improves interest rates for other loans. That can improve your financial stability," says Bill Hardekopf, CEO of LowCards.com and author of The Credit Card Guidebook.
LowCards.com ( http://www.lowcards.com ) simplifies the confusion of shopping for credit cards. It is a free, independent website that helps consumers easily compare credit cards in a variety of categories such as lowest rates, rewards, rebates, balance transfers and lowest introductory rates. It also gives an unbiased ranking and review for each card. The LowCards.com Complete Credit Card Index ( http://www.lowcards.com/CreditCardIndex.aspx ) is the most objective and comprehensive resource on the Internet which allows consumers to compare rates for all 1060 credit cards offered in this country. Created by Hampton & Associates, the company has been analyzing the credit card industry and supplying objective websites on various consumer expenses for ten years.