It's Not Fun, but It Has to be Done Benjamin Franklin wrote a 1789 letter that states, “But in this world nothing can be said to be certain, except death and taxes.” Even at the United States’ early beginnings, federal taxes were a necessary evil to fund various public projects and administrative costs. Today, federal taxes serve much of the same purpose. While virtually no one likes to prepare and file their taxes, it is a necessity if you want to avoid fines and further hassle. It is no secret that preparing and filing your taxes is notoriously complicated. Many people lament that it should not be so difficult to pay the government. However, some of the complications allow people to save money if they discover specific tax benefits. Knowing how to file your own taxes may be a good option if your tax situation is relatively straightforward, or if you are willing to learn the process. Why Do You Need to File Your Taxes Every Year? The short answer is that federal law requires that most individuals file taxes annually. Income taxes are assessed every year based on your income earned during that period. You then pay a percentage of that income to the government, less any deductions, adjustments, or credits that you qualify to receive. If you do not file (and pay) your taxes, then you may be assessed penalties and interest. The Internal Revenue Service (IRS) can even go as far as garnishing your wages and repossessing your property if you do not file and pay as required. The Benefits of Filing Your Own Taxes If you are one of the 43% of Americans that are doing your own taxes, you are certainly not alone. Roughly 53 million people prepared and filed their own taxes in 2018. There are many benefits to filing your own taxes, including: Saving money: Hiring a tax professional is expensive, and many people can prepare and file their returns on their own, completely free of charge. Control: Some people like knowing the exact information that is included in their return and being able to control the data, and for some, knowing precisely how the numbers work out, is comforting. Gain helpful information: When you prepare your taxes, you can see what items saved you money this year or which issues you should address so you can save money next year. While filing your own taxes is complicated, it can be beneficial under the right circumstances. There are several programs online that walk you through the process to help ensure you are taking advantage of all of your available deductions and credits. The Drawbacks of Filing Your Own Taxes In addition to the benefits, there are also some disadvantages to filing your own taxes. These include: Time and effort: Preparing and filing your taxes takes time and work You have to sift through financial information and deal with concepts that you may not understand well. The process can be frustrating and take a considerable amount of time. Error risk: If you do not completely understand how your taxes work, you run the risk of making a mistake because of misconceptions. If that happens, it could lead to underpayment and audits down the road. Questions: Even if you use a tax preparation software, you may still have questions that will remain unanswered unless you do significant research or reach out to a tax professional. For some people, the risk of having a substantial error that triggers the IRS’s attention is enough to scare them away from preparing their own taxes. Preparing for Filing Your Taxes When you begin work on your taxes, you should have information gathered throughout the year. Some of the most common items that you will need include: Social Security numbers for you, your spouse, and any dependents Information about wages, such as W2s or 1099s Investment income information Documents that represent any other source of income Information regarding adjustments to income, such as student loan interest paid, IRA contributions, and health savings account contributions, just to name a few Information regarding potential credits, including, for example, child care expenses, education expenses, or retirement savings contributions Data about any tax payments that you may have made throughout the year Keeping good records will help make tax preparation easier at the beginning of the year. [youmaylike] The Basics About What You Can Claim When Filing You must pay income taxes on all your income earned throughout the year. However, that income is reduced by a few things. The further you can reduce your taxable income, the less you tax you will pay. There are three general categories of tax reduction methods: Standard or Itemized Deductions Everyone can claim either the standard or itemized deductions. Standard deductions are a set amount that is based on your filing status. Itemized deductions are based on actual expenses that you incurred throughout the year. You can choose to use the higher deduction. The higher the deduction, the less tax you will have to pay on your income because your income decreases on paper. Itemized deductions include things like medical expenses, state and local tax payments, and home mortgage interest deductions. Itemized deductions will only decrease your income by a certain percentage, or up to a specific point. Adjustments Some adjustments to your income may also be available. These include things like paying student loan interest or alimony. Adjustments are more valuable compared to deductions because they decrease your income dollar for dollar. Credits A credit decreases your taxable income as well. Some credits are refundable while others are not. For example, you get a child tax credit simply for having children that qualify for that credit, but that credit will not be paid out to you if you do not have any tax obligations. On the other hand, the Earned Income Credit, which is available for low-income filers, will be refunded to you even if you do not owe any taxes. There are a wide variety of deductions and credits available. Take a look at the federal forms and related schedules to determine whether you might qualify for any of these. How to File Your Own Taxes If You Live Overseas If you earned income in the United States as a U.S. citizen or resident alien, you likely need to pay taxes on that income. This is true even if you live overseas. You can still choose to e-file or mail your tax return to the IRS once you have it prepared, just as if you physically lived in the United States. In some cases, you will be taxed on the income that you earned throughout the world. However, you may be able to deduct a portion or all of the revenue that was not made in the United States in some circumstances. Filing Online The IRS offers an online filing option that is free for individuals that have an adjusted gross income below a specific threshold. Generally, your income must be below $66,000 to qualify for this service. You can also file online by using a commercial tax preparation software. Examples of this type of software include: H&R Block TurboTax TaxCut TaxSlayer There are many programs available that will file your taxes for you, often for a fee. Knowing how to file your own taxes can be a great way to save money, but it can be tricky as well. If you want to file your taxes yourself, be sure to read the form instructions thoroughly and get familiar with various tax saving opportunities before you begin preparing your return.
What Can You Afford?
Debt is an unfortunate reality for the majority of Americans.
Some people think debt is always bad. They’ll repeat mantras like “there’s no such thing as good debt,” likely remembering their days of struggling with student loan or credit card debt.
But these folks are short-sighted. The important thing to remember is debt is a tool that can be effectively used to your advantage. Borrowing $30,000 to spend on an education that will increase your earning power by $15,000 per year is a fantastic investment, even if it takes years to pay it back. So is buying a sensible car so you can get to work or getting a mortgage to protect yourself from greedy landlords raising rents in a hot housing market.
There are two important things to remember when taking out debt. The first is to always use debt to buy assets, not liabilities. Borrowing to buy a house or finance an education is fine. Using credit cards to finance a vacation or some other consumable isn’t a good idea. Second, make sure you have a good idea of what you’re signing up for. Think about your new potential debt critically before signing up. Can you really afford it? Is it really necessary?
We can help with that second part. We’ve created a loan calculator you’re going to want to consult before signing on the dotted line. Let’s take a closer look at how it works as well as some general tips for getting out of debt as quickly as possible.
The Loan Calculator
This calculator will break down what your loan payment will be, but you’ll need to provide it with the following inputs first:
This doesn’t need much explanation. This is the amount you’re going to borrow. Make sure you add any loan fees (if applicable) to the face value of your loan.
Another simple category. This will be prominently displayed on any loan agreement.
It’s fine to input an estimated interest rate if you’ve just begun the process of shopping for a mortgage or car loan. A little online research will reveal what the going rates are for each type of loan.
This is also called the amortization period. It’s how long the loan will take to be paid back. Car loans will typically stretch for anywhere from three to seven years, while mortgages are a 15- to 30-year commitment.
And that’s it. The calculator will take these variables and use them to determine your loan payment. Feel free to play around; you’ll see how extending the loan period will make a loan more affordable. But remember, doing that will increase the total interest cost of the loan.
Next we’ll take a look at different types of loans you might get, and what you’ll need to know before agreeing to the commitment.
Types of Loans
A loan can be arranged on any asset, provided you have a lender and a borrower agree to terms. But ultimately they boil down to two different kinds: installment and revolving loans.
We’ll start with an installment, or fixed, loan. This is your standard loan where a borrower takes a fixed amount and slowly pays it off over a period of time at a fixed payment plan. The banking industry refers to these as installment loans.
A car loan is an installment loan. So are student loans. A mortgage is as well, although the payment could fluctuate if you’ve taken out a variable rate mortgage. Those mortgages aren’t so common nowadays, since they didn’t tend to work out so well for borrowers in 2006-08. Most borrowers prefer the security of a fixed monthly payment.
Typically, a standard installment loan will never stretch out for longer than the life of the underlying asset. This means that a car loan must be paid off relatively quickly, since the lender doesn’t want a borrower to continue paying something off after it has become worthless. An education or a house are both assets that can last decades, so banks allow borrowers to pay them back slowly. These loans also tend to have lower interest rates because they’re backed by secure assets.
Compare that to a payday loan, a short-term loan that only lasts a couple of weeks. Payday loans come with the highest interest rates of all because they’re given to folks with poor credit who have just admitted to having money management problems. You’re looking at interest rates of 25% over just a week or two. It’s best to avoid payday loans at all costs.
Next, let's talk about revolving loans, flexible loans that can fluctuate depending on how much the debtor needs to borrow. The two main types of revolving loans are credit cards and lines of credit.
A revolving loan will give the borrower the flexibility to borrow up to a predetermined limit with interest being charged on just the balance owing. Repayment terms will be more flexible as well, with a borrower being allowed to pay as little as a small monthly minimum or a maximum of the entire balance.
Revolving loans can be secured against assets. Home owners commonly take out lines of credit that are secured by the equity in their property to pay for home improvements or to just consolidate other bills. These special lines of credit — which are called home equity lines of credit (or HELOCs) — are offered at similar rates to mortgages since they’re secured by the value of the home.
Unsecured lines of credit exist, but most folks access revolving credit through credit cards. An unsecured loan doesn’t have any specific asset a lender can seize if the borrower stops paying. These loans are only secured by the general credit worthiness of the borrower. This works most of the time, since the majority of people don’t default on debts unless they have no other choice.
Credit cards are extremely flexible and offer a low, mandatory monthly payment. Borrowers pay for this privilege through high interest rates on any outstanding balance. Credit card interest will set you back anywhere from 1-3% per month.
Remember, credit cards aren’t secured by anything physical. If you stop paying your credit card, the bank is going to have to do some work to get you to pay. Interest rates charged to credit card borrowers reflect that risk.
Picking a Lender
Many borrowers are so worried they’ll get denied a loan (despite excellent credit) that they take the first offer put in front of them. Many banks count on this when applicants want a mortgage or car loan. A little negotiation can go a long way.
It’s amazing how threatening to walk away from a loan will get a lender to lower their interest rate. Even a reduction of half a percent can mean a lot of money over the life of a loan, especially when we’re talking long-term mortgages.
It also makes a ton of sense to shop a few different lenders before making a big purchase. Leverage each lender against the previous one until you come up with the best rate. A mortgage broker can help with this when buying a house, especially if you don’t have the time nor the ambition to talk to a few different lenders.
Interest rates aren’t everything, however. You’ll also want the flexibility to make extra payments on a loan if you’re serious about slaying debt quickly. Sometimes a bank will give borrowers the lowest rate but will lock them into a contract that won’t give any flexibility.
Paying back a loan early can result in some serious savings. Say you borrow $30,000 over a five-year term at 5% interest. If you take all five years to pay back the loan, you’re looking at interest costs of almost $4,000. But if the same loan is paid back in three years, the total cost of borrowing is just over $2,300.
Who couldn’t use an extra $1,700? That’s how much you can save paying back a loan early.
Don’t forget about other factors when choosing your lender. Some banks offer excellent customer service. Others might offer free banking packages for borrowers. These perks matter, especially for somebody with good credit who is likely receiving similar offers from every lender.
Getting out of Debt
It doesn’t matter if you’re wallowing in debt or have a relatively clean personal balance sheet, it’s still a good idea to get out of debt as quickly as possible. You want to be earning interest, not paying it.
Good debt habits mirror good personal finance habits. To get out of debt quickly you’ll need to free up cash dedicated to other expenses and funnel it toward clearing up loans. This means spending less on everything, especially the big three expenses of housing, transportation and food.
One way to minimize your debt before you even start is to reduce the amount you borrow in the first place. If your bank tells you a $30,000 car loan won’t stretch your budget, opt for a $20,000 loan instead. Do the same thing with your mortgage. You’ll free up hundreds of dollars each month, which can then be thrown at the loan to pay it down all the faster.
Many people have had success using the snowball method to get rid of debt. You tackle the smallest debt first, throwing as much as possible toward it while making minimum payments on your other debts. Once the lowest balance is eliminated, move to the next lowest.
The snowball method gives borrowers psychological victories, which will encourage them to keep going. And it frees up having to make so many minimum payments. But it doesn’t factor in interest rates charged. You’ll want to do the math and maybe alter the snowball method a little before starting.
Improving your credit score is another way you’ll spend less on loans over the long-term and get out of debt faster.
While the exact formula used to determine your credit score is a tightly guarded secret, there are easy moves you can take to improve your score. You’ll want to clear up any accounts that are delinquent. Reducing your current debt-to-available-debt ratio on your credit cards will also help. Applications for new credit will also reduce your score, so keep those to a minimum.
Ultimately, getting a good credit score comes down to paying your bills on time. As long as you keep your creditors happy, it’ll be reflected in your score.
Smart borrowers can also refinance debt to lessen the pressure.
Say you’re struggling with credit card debt, but still have a good credit score. You could apply for a debt consolidation loan at a much lower interest rate, which would immediately decrease your monthly payments. When done right, a debt consolidation loan will save you thousands in interest.
Many credit cards love these types of borrowers, and will offer low-interest balance transfers to entice them to switch card providers. I’d caution people to be careful before accepting one of these offers, however. Once the initial grace period runs out, you’ll be right back to the same high-interest situation with this new card. You’ll want to make sure a serious dent is made to that balance while the rate charged is low.
Ultimately, getting out of debt won’t be easy. It’ll require months — if not years — of sacrifice.
The Bottom Line
Debt gets a bad rap, especially from people who have struggled with it. Some of these naysayers go as far as calling debt “evil” and proclaiming there’s no such thing as good debt.
I disagree. Avoiding debt is a good idea, especially high interest rates offered by credit cards or payday loans. But when used intelligently, debt is a tool that can better your life in so many ways.
There’s nothing wrong with financing big ticket items like a house, car or your education, provided these are done responsibly. Keep your payments low and you’ll be fine.
This calculator will help you use debt better, and the tips provided will allow you to get out of debt quickly, minimizing the total interest.