Tax Return Loans and Why They May Be a Bad Idea

A "Refund Anticipation Loan" (RAL) is a loan made by a lender that is based on and repaid by an anticipated federal income tax refund. Companies specializing in these loans offer these services during tax season. They also generally charge taxpayers fees and interest to obtain an RAL. According to the National Consumer Law Center (NCLC), twelve million taxpayers used an RAL in 2004.

The Basics

RALs are short-term loans based on the expected tax refund. With an RAL, a third-party lender will offer the taxpayer an immediate loan somewhat smaller than the actual refund so the taxpayer will have immediate cash before receiving the refund. The loan is secured by the anticipated refund.

Tax Refund Advance

In addition to RALs, a taxpayer can obtain an immediate tax refund by getting a tax refund advance. It is similar to an RAL and sometimes referred to as an instant refund. A tax refund advance is essentially a loan from the tax preparation service used to file the return. Many taxpayers like to request a tax refund advance because it's fast and taxpayers can receive the money as soon as their tax return is accepted by the IRS. Once the loan is received, a taxpayer need not worry about repayment because the IRS will send the tax refund check to the tax preparation service that provided the tax refund advance.

However, tax refund advances are no longer popular. With e-filing and IRS partnerships that help consumers e-file for free, U.S. taxpayers can generally receive their tax refunds within three weeks and sometimes as quickly as ten to fourteen days if they choose to receive their refund via direct deposit.

The Costs

Pundits accuse those providing tax refund loans as charging predatory fees for RALS, similar to fees for payday and title loans. Although the fees may seem small compared to the size of the refund, an RAL can be expensive in respect of the shelf life of the loan. In fact, in 2006, the NCLC and the Consumer Federation of America conducted a joint study on RALs. They determined that, on average, a consumer will pay approximately $100 for a refund of approximately $2,150. Effectively, consumers are paying 5 percent of their return to a short term loan, which can be for less than two weeks. That percentage is obscenely high on a short-term loan.

Nonetheless, each taxpayer's circumstance is different. While patience is a virtue, some taxpayers may need cash immediately, making an RAL a necessity. Having patience for a refund does not pay the mortgage.

The days of long waits for tax refunds are over. Due to improved speed, there is less of a need for tax return loans. While some taxpayer's circumstances will find such loans useful, modern technology lessens the need for such loans, which may be predatory anyway.