08 May What’s the best way to pay off my tax debt?

Q. I owed $12,000 in federal tax and $2,000 in state tax on my 2025 return. I decided to use a HELOC to pay for it because I didn’t have enough cash. I have $6,000 in an emergency fund and the rest of my assets are in retirement accounts. What are the pros and cons of using the emergency fund to pay off half the HELOC, or instead should I just do the monthly payments? The HELOC, if I pay interest only, which is an option, is about $100 a month, while if I pay principal and interest on a 10-year payment, it would be about $165 a month. My initial thought was I could refinance the whole mortgage at some point, but it’s not looking good for interest rates right now.
— Taxing troubles

A. We’re sorry to hear you owed money after completing your tax returns.

Let’s talk it through.

There’s no one “perfect” answer to your question, but there is a clear way to think about this, said Matthew DeFelice, a certified financial planner with U.S. Financial Services in Fairfield.

He said you essentially have competing priorities here: staying liquid (i.e. keeping your emergency fund intact), or minimizing your interest cost and keeping your monthly cash flow comfortable.

“I don’t think using the $6,000 cash you have on hand to pay down the HELOC makes a lot of sense,” DeFelice said. “It won’t pay off the full amount you borrowed and will still leave you with a monthly payment to make.”

Additionally, it will completely drain your savings, forcing you to borrow more if you run into additional unforeseen expenses like your hot water heater breaking, he added.

“Given that the rest of your assets are in retirement accounts, I think you need to retain some level of liquidity. And the monthly payments should be manageable,” he said.

That being said, a $100/month interest-only payment on $14,000 borrowed implies a rate in the 8 to 9% range.

“That’s not cheap debt,” he said. “HELOC rates are also variable, so they could rise.”

In your head, you should treat this like moderately high-interest debt, not something you want to casually carry forever but something that you can float temporarily, he said.

He also said he would avoid the interest-only payment option if you can swing it.

“Interest only payments keep you stuck in a loop where you never actually pay down the debt, and you would be exposed to interest rate increases creating higher payments,” he said. “You are just treading water, whereas making principal+interest payments can actually help solve the problem.”

Instead of an all-or-nothing decision, one middle ground to consider would be to use maybe $2,000 to $3,000 of your emergency fund to pay down some of the debt now, and then make the monthly principal+interest payments, DeFelice said. You wouldn’t be draining your emergency fund to zero (keeping at least a $3,000 to $4,000 cushion), and you’d use the excess toward the HELOC balance up front. This will lower your total interest cost while still preserving liquidity, he said.

Regarding the refinance option, your thought to roll this into a mortgage later isn’t ideal, he said.

“You’d be turning a short-term tax obligation into long-term debt, and likely at similar or higher rates anyway,” DeFelice said. “The better mindset would be to treat this as a 1- to 3-year cleanup, not something to stretch out over 20 or 30 years.”

He made one more observation, nothing that you essentially used debt to cover a one-time tax obligation.

“That’s fine—but now your real goal should be to avoid repeating this cycle,” he said. “For 2026, I would consider adjusting withholding or making estimated tax payments so you’re not short again next April. Even making modest quarterly payments can prevent needing to borrow again.”

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This story was originally published in May 2026. 

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.