When money's tight, a quick cash infusion is hard to resist. That's why tax refund anticipation loans (RALs) continue to lure consumers -- 8.4 million of them in 2008, according to the latest figures from the National Consumer Law Center (NCLC: undefined, undefined, undefined%) and the Consumer Federation of America (CFA: undefined, undefined, undefined%) -- even though they come with a hefty price of excessive fees and surcharges.
How refund anticipation loans work
A refund anticipation loan is a short-term cash advance against an anticipated tax refund. Here's how it works:
- Consumers pay a loan fee, and sometimes an application or administrative fee, to their tax preparers and a participating financial institution, and those fees can range anywhere from $50 to several hundred dollars, depending on the size of the refund.
- Banks then issue a short-term loan to the consumer within a day or two, and the tax preparer acts as the intermediary between the customer and bank.
- When the refund is processed by the IRS, the funds are then transferred back to the bank that issued the loan.
- If the consumer wants the cash immediately, then another fee is typically added on.
RALs drained the refunds of 8.4 million American taxpayers in 2008, costing them $738 million in loan fees, plus over $68 million in other fees, the NCLC and CFA said in a Jan. 19, 2010 report. About 1 in 17 tax returns involved a RAL.
Also pitched as "fast cash," "refund now" or "instant cash," RALs, which emerged in the early 1990s, are offered primarily through big national tax preparation firms, such as H&R Block and Jackson-Hewitt, though smaller, independent firms can offer them, too. In addition to the bank fee and the application fee, consumers must also pay the preparer for assembling the tax return.
If a taxpayer chooses to file electronically for their return instead of opting for a RAL, the waiting period for the funds to be directly deposited into a bank account is typically the same amount of time -- about two weeks -- and it's free.
"A RAL is like opting for overnight shipping for faster delivery and being willing to pay more for quicker service," says Debbie Whiteley, executive vice president of investor relations for Santa Barbara, Calif.-based Pacific Capital Bancorp, the parent for Santa Barbara Bank & Trust, which processed refund anticipation loans for Jackson Hewitt until it was ordered out of the RAL business by federal regulators in 2009. RALs enjoy better than 70 percent annual repeat business, says Whiteley.
SBBT processed 1.83 million refund anticipation loans in 2007, earning $118 million in fees, as one of the higher-priced RAL lenders, according to Robert Hobbs, deputy director of the Boston-based National Consumer Law Center. SBBT charged about 40 percent more than some of its competitors, says Hobbs.
RALs target the poor
Consumer protection groups, however, have long been trying to get the word out that RALs target low-income and unbanked consumers -- particularly those who qualify for the Earned Income Tax Credit (EITC: undefined, undefined, undefined%).
"The tax refund is often the biggest chunk of money low-to-moderate income taxpayers get all year," says Chi Chi Wu, NCLC staff attorney. Adds Peter Skillern, executive director of the Community Reinvestment Association of North Carolina, 63 percent to probably more than 85 percent of households receiving the EITC are targeted for refund anticipation loans. The EITC is a federal refundable income tax credit for low-income working individuals and families.CFA and NCLC estimate these families lost approximately $800 million from "quickie tax refund loans."
"The RAL industry would collapse if EITC people weren't being marketed to," says Skillern.
Other lures of refund anticipation loans are that they offer a way to pay for tax preparation without any out-of-pocket expenses and cater to consumers who don't have bank accounts to accommodate direct deposits. But when you consider the high -- up to 500 percent to 700 percent in some cases -- interest rates if annualized, plus fees to get your refund faster, the instant gratification comes at a high price. Consumer advocates say the high costs of a refund anticipation loans aren't transparent enough when marketed to the public.
If paying for tax preparation is a concern, tax and consumer experts say that you can get your taxes prepared for free. "There are volunteer organizations that prepare taxes for low-to-moderate income families without charge," says Catherine Williams, vice president of financial literacy for Houston-based Money Management International. The IRS Web site offers a toll-free number, (800) 829-1040, to locate the nearest free community-based site.
For consumers without bank accounts, it may be helpful to know that some banks will open accounts without fees. "Even with fees, you can open one for a month just to accept a direct-deposited refund, which is still cheaper than an RAL," says William Henry Jones, member and former chairman of the Taxation of Individuals Committee for the New York State Society of Certified Public Accountants.
IRS, states take on RALs
The free-flying era of RALs may soon be clipped, however. After several years of wrangling with the issue, in January 2009 the IRS proposed new regulations that would prevent tax preparers from disclosing tax return information to a third party (which in this case would be the financial institution issuing the loan) for the purpose of selling refund anticipation loans.
While the proposals put forth by the IRS haven't yielded any final rulings, the agency had tax preparation firms that joined its Free File e-filing program agree to remove all ancillary offerings such as refund anticipation loans.
And on Jan. 2, 2009, H&R Block agreed to halt marketing refund anticipation loans in the state of California as "early tax refunds." The decision settled a 2006 lawsuit with California Attorney General Jerry Brown. As a result of the settlement, the company agreed to pay $2.45 million in restitution to customers, as well as paying $500,000 in penalties and $1.9 million in fees and costs. The company admitted no wrongdoing.
Patience pays off in dollars
The temptation to run to the nearest tax preparer with your W-2s, or even with just your paystubs and thus estimating refunds, proves too tempting for many. Unfortunately, mistakes do happen. That big refund may be illusory when you discover later that the form was filled out incorrectly and only $74 is coming to you or that you owe child support payments that will be withheld, but you've already spent the refund. Kevin McKeon, a spokesman for the IRS, says that these "offsets" do absolutely occur with refund anticipation loans. "It could be because of state back taxes, a student loan, or child support," says McKeon.
If you use loan money to pay off credit card debt, you could almost see its usefulness, says MMI's Williams, but because it's seen as "gift money" it's often used for purchases such as a big screen TV to watch the Super Bowl. This simply is a lose-lose proposition, say consumer groups.
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