In the last few years, all kinds of industries have jumped on the IRS tax refund bandwagon. Almost half of Americans are issued refunds after filing their taxes, resulting in a profitable marketplace for a number of creative consumer opportunities. There are special deals on cars, deals on furniture, gift cards and more.
Most tax refund deals promise to add some sort of premium to your refund and can be great ideas, especially if the timing is right – say, for example, if you happen to be planning to buy a car or a sofa and that purchase is a part of your regular budget.
A cash tax refund anticipation loan, however, is an entirely different story. A refund anticipation loan, also known as an RAL, is a way for a tax filer to get his refund immediately. The tax preparation company walks the consumer through filing their taxes, determines the amount of the refund, and then offers to give the refund cash to the individual on the spot – minus a few fees. In return, the company gets to keep the customer’s refund when it is issued by the Internal Revenue Service.
There are several reasons why this kind of loan is not a wise financial decision. Yet more than 7 million tax filers take advantage of these quickie tax loans each year, and that number is growing.
Who Gets Refund Anticipation Loans?
Consumer watchdogs view RALs as predatory because they focus on lower income individuals and families. Why are low income taxpayers the focus of RALs?
- Cash Flow Issues. Because people in low income brackets often have cash flow problems, they view their tax refund as a golden opportunity to address that issue for a month or two.
- No Checking Account. How long does it take to get your tax refund? The fastest way to get an IRS tax refund is via direct deposit, but over 25% of Americans (mostly lower income families) do not have checking accounts. The refund anticipation loan allows them to get their cash in a matter of days, while it might take over a month for a paper check to be sent.
Those who offer RALs keep an eye out for taxpayers who are desperate for cash. Under the guise of being helpful, they convince these people to take loans that end up netting the loan provider a tidy profit.
Who Offers Them?
For several years, the largest seller of RALs was H&R Block. Recently, though, a somewhat surprising ruling by the U.S. Office of the Comptroller of the Currency greatly diminished H&R Block’s ability to process and issue RALs.
This year, Jackson Hewitt has become the largest purveyor of refund anticipation loans, followed by the much smaller Liberty Tax Service. Most tax preparers offer some form of refund anticipation compensation.
How Do RALs Work?
As stated above, these loans are typically offered by tax preparation services. The loan is offered based on the amount of the tax payer’s refund. They then deduct any fees or interest before issuing the loan.
In theory, the loan will be paid off when the tax preparation service receives your tax refund check. If your refund is less than originally anticipated (for instance, if traffic tickets or child support obligations are deducted), you will be held responsible for the remaining amount.
If you think that this sounds like a pretty good deal, since you’ll just get a check without having to worry about making loan payments, think again. The fees and APR on these loans are just shy of highway robbery.
RAL fees and interest can add up to over $250 and shrink your refund by as much as 10 percent, with APRs well over 30%. The Consumer Federation of American states:
“The effective APR for RALs based on a 10-day loan period ranges from about 50% (for a loan of $10,000) to nearly 500% (for a loan of $300). The APR for a typical RAL of about $3,000 can be from 77% to 140%.”
The greater reality is that refund anticipation loans last far longer than ten days. Keep this in mind if you find yourself tempted by an RAL offer when working with a tax preparation company.
Typically, the RAL is issued in the form of a debit card from the tax preparer. However there are many businesses who offer “soft” RALs. A soft RAL is when you prove the size of your refund to a business, and then that business offers merchandise or an in-store gift card that is equivalent to the refund you anticipate. Again, this is not a true refund anticipation loan and there are instances when these types of refund advances are a good deal.
Why Are Refund Anticipation Loans a Bad Idea?
Obviously not everyone considers an RAL to be a bad idea. At least 7 million taxpayers believe that their situation calls for this kind of measure, but I believe that these loans are a bad move in almost every situation. Here are three reasons why:
- High Cost. The most obvious reason against getting a refund anticipation loan is the price demanded by this loan. The minimum total cost seems to be in the neighborhood of 30%, depending on how long it takes for your lender to receive your refund.
- Unethical Motivation. Tax fraud is a serious issue. Your refund anticipation loan provider’s compensation is connected to the size of your refund. By depending on your tax preparer to give you a loan based on the estimated amount of your refund, you are placing incentive in front of him to find more tax deductions than the law allows, or to take more risks on your return. None of us want the IRS coming back in a few years, asking for a check to make up for tax filing mistakes and errors. And there are some deductions that greatly increase the risk of an IRS tax audit.
- Indicator of Serious Problems. If you are so desperate for your tax refund that you are willing to pay 30-50% interest in order to get that cash in your hand, you need help, plain and simple. You need to make a budget, figure out the reasons for your debt problems, and maybe even find a second job. In other words, your financial life is in serious trouble and it is time to take drastic measures to improve.
Are RALs Ever a Good Idea?
The answer is simple: No, refund anticipation loans are never a good idea. With that said, they can be the lesser of two evils.
For example, if you are seriously considering taking out a payday loan or a paycheck advance loan, go with an RAL instead. Why? When you take out a payday loan, you are borrowing above and beyond your means, meaning that you are borrowing directly against your normal cash flow. As a result, payday loans, along with their enormously high interest rates, can cause a vicious cycle that can ultimately leave you in a dire financial situation.
On the other hand, an RAL is simply an advancement on money that you are owed by the IRS. Thus, you will not necessarily find yourself in debt even after paying a high fee or interest rate. For example, if you are expecting a tax refund of $3,000 and pay $200 in fees, you still come out $2,800 in the black without having to owe any debt. Of course, if you had just waited for your refund, it could have been a full $3,000, but you are at least still net positive.
In short, do not get a refund anticipation loan. An RAL is immediate gratification in the most extreme form. Legislation is being considered in many states and even federally that would restrict or ban refund anticipation loans. That is how badly many government officials view this financial strategy.
But you don’t need the government to tell you that a refund anticipation loan is something to be avoided, do you? Don’t wait for lawmakers to take action. Instead, take steps to ensure that you aren’t financially reliant on your tax refund or adjust your federal income tax withholding exemptions so that your refund isn’t so high.
If you do find yourself needing the money sooner rather than later, e-file with one of the many free online tax preparation software and services and have your refund money direct deposited into your account. You may have to wait a few extra days, but in the end, you’ll have every penny you deserve.