Tax Refund Loans—Immediate Gratification at a Steep Price
As tax season speeds into high gear, put the brakes on "fast refunds" that come in the form of refund anticipation loans, or RALs. It's a costly option millions of taxpayers take, often without realizing just how expensive—and probably unnecessary—it really is. According to the National Consumer Law Center and Consumer Federation of America, consumers lost an estimated $1.24 billion in tax refunds through the payment of RAL fees in 2004. This publication discusses RALs and describes alternatives that are cheaper, less risky and just plain better money management.
How RALs Work (Against You)
With a RAL, you are effectively paying to borrow your own money. RALs are short-term bank loans—usually with terms of only 7 to 14 days—that are secured by your expected refund. Taxpayers who take out RALs receive cash, typically right away, in the amount of their anticipated refund—minus fees. In exchange, they agree to pay an interest rate that could, when expressed as an annual percentage rate (APR), add up to a triple-digit rate. In most cases, the lender then sets up an account that is used solely to receive the taxpayer's IRS refund. When the refund arrives, it is used to pay off the loan.
Like all loans, RALs come with risk, including an increased debt burden if your refund is denied, delayed or lower than expected. As costly as RALs can be in the short-term, they can be devastatingly expensive over the long-term should anything go wrong with your refund, piling up significant debt over time and hurting your credit score.
The High Cost of RALs
RALs come with a number of fees, which may include:
- A loan application fee that can be as high as $100;
- A tax preparation fee, usually starting at around $40;
- A check processing fee (around $20);
- A "Peace of Mind" guarantee from your tax preparer that you will get the refund cited on your tax form, which can cost you an additional $100 or more.
- A refund account fee, for services involved in setting up a temporary account into which the taxpayer's refund is later deposited to repay the RAL. Expect to be charged a minimum of $30, but it could be higher. This fee generally is paid by those who have no bank account of their own.
In addition to fees, RALs come with high rates of interest—generally starting at 36 percent and going up from there. With fees included, effective APRs can exceed 700 percent. Indeed, costs are so high that some payday lenders are actually advertising that their products are a bargain compared to RALs.
Bottom line: Expect to pay a minimum of $200 on a $2000 tax refund that may come to you in as little as 10 days.
|RALs and Military Personnel
In 2006, Congress enacted the Military Lending Act to protect active duty servicemembers from predatory lending practices. The law prohibits RAL lenders from charging more than 36 percent APR—including interest and fees—on loans made to servicemembers. While the cap has resulted in a decline in RAL marketing to servicemembers, it has not eliminated it.
Members of the military are encouraged to take advantage of tax preparation assistance that is generally offered free of charge on or near their installation. Servicemembers and their families can also take advantage of financial and debt management assistance, which is offered through the military's network of family support centers.
Running Into RALs
Businesses that prepare and file tax returns are the place most consumers run into these "instant refunds." But they aren't the only place where you may be pitched to take out a RAL. Car dealerships, boat showrooms, and furniture and electronics stores are among the many businesses that offer these loans, enticing you to apply your expected tax refund toward the purchase the products sold at these establishments.
Resist the urge. If you must buy on credit, there are almost always less expensive ways to pay for a car, boat, bed or big screen TV.
The good news is that there are better, less expensive and more prudent alternatives to RALs.
- Wait for Uncle Sam—The best move is to be patient and have the IRS send your tax refund free of charge. If you e-file and select the option to have your refund directly deposited, the IRS refund cycle can be as short as 8 days. Patience is a virtue—and makes sound financial sense. In many cases, waiting only a few days or weeks can save hundreds of dollars.
- Use Direct Deposit—Open a checking or savings account, so your refund can be directly deposited. This service is generally free at most banks and credit unions. Without an account, you may be charged additional fees to cash a paper tax refund check, even though the payor is the U.S. Treasury, a department of the federal government.
- Get Help for Free—Take advantage of free tax preparation programs offered by the IRS. The Volunteer Income Tax Assistance Program (VITA) offers free tax help to low- to moderate-income (generally, $40,000 and below) taxpayers who cannot prepare their own tax returns. The Armed Forces Tax Council coordinates VITA centers on military installations worldwide, providing free tax advice and preparation to servicemembers and their families. Other consumers can locate the nearest VITA site by calling (800) 829-1040. In addition, the IRS's The Tax Counseling for the Elderly (TCE) Program provides free tax help to people age 60 and older.
Be a smart consumer. Don't take a bite out of your tax refund by taking out a RAL.