Tax Refund Loans

Individuals in need of a short term loan can use their tax refund as collateral.  While this affords taxpayers fast access to their refund dollars, this convenience comes with a high price.

In this article, we're going to discuss the topic of tax refund loans.  As part of that discussion, we'll talk about the application process.  Next, we'll discuss their pros and cons.  Finally, we'll talk about some of the alternatives to this financing arrangement.

Loans Secured by Tax Refunds

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Also known as state and federal refund anticipation checks (RAC), refund anticipation loans (RAL), and instant refund loans, these short-term loans are meant to offer consumers fast access to their income tax refund dollars.  Instead of waiting weeks to receive their full refund from the IRS, these offerings provide taxpayers with the convenience of receiving their money in the near-term, minus the associated fees and interest charges.

Generally, the process of obtaining a tax refund loan works something like this:

  1. Tax Return Prepared:  the filer's income tax return is prepared, and the resulting calculation indicates the filer is entitled to a refund.
  2. Loan Offered:  while loans are offered over the Internet, most customers are provided the opportunity to obtain a loan through their tax preparer.  At this point, the borrower will be informed of the terms and conditions of the loan.
  3. Authorization Form:  a standard form is filled out, authorizing the IRS to deposit the borrower's tax refund directly into an account of the lender.
  4. Loan Approval:  once all the forms have been completed, and the loan is secured by the tax refund, the borrower is usually approved by a banking institution that works with the tax preparer.
  5. Money Received:  once approved, the borrower can receive their refund (less fees and interest charges) "on the spot."  Payment may be received by check, direct deposit, or through prepaid debit cards.

Loan Fees

With a refund anticipation loan, the borrower receives only a portion of their refund.  Any fees owed to the tax preparer and bank is first subtracted from the refund amount to derive the net dollars paid the borrower.

The fees associated with these loans are considered high, given the fact the money is repaid to the lender by federal or state treasury departments.  Borrowers can expect to pay tax preparation, administrative, and processing fees along with finance charges.

The following table contains an actual sampling of loan amounts and fees charged by online service providers:

Loan Amount Fees APR
$500 $77.50 115% to 514%
$1,000 $95.00 71% to 315%
$2,000 $130.00 48% to 216%
$3,000 $160.00 40% to 177%

NoteAnnual Percentage Rate on these loans was calculated based on the assumption the time to receive the tax refund from the IRS could range from as little as 11 days (electronic filing and direct deposit) to as long as 7 weeks (filing by mail and check by mail).

Pros and Cons

The only advantage of RALs is the convenience of gaining immediate access to tax refund dollars.  Unfortunately, borrowers pay a high price for this convenience.

According to information published by the IRS, 18.3 million taxpayers obtained a refund anticipation check in 2011, resulting in $550 million in direct fees. Consumers oftentimes pay add-on fees, bringing the total RAC fees to $700 million.

The price for non-bank refund anticipation loans is even higher, witch 15-day loans carrying APRs that approach 700%.

Alternatives

The perfect alternative to a tax refund loan is to eliminate the need to borrow money in the first place.  This can be achieved by waiting for the refund to be received directly from the IRS.  Some of the other options to tax refund loans include:

  • IRS Refund Check:  it's possible to receive a refund through the U.S. mail.  If the tax return is mailed to the IRS, and a check mailed back home, this cycle time can take as long as seven weeks.  Alternatively, it's possible to file a return electronically, and receive a check by mail in as little as three weeks.
  • Direct Deposit:  the most time-efficient way to receive a refund directly from the IRS is to file an income tax return electronically, and receive a refund in the form of a direct deposit into a bank account.  The cycle time for this option ranges from eight to fifteen days.
  • Household Budgets:  another way to eliminate the need for immediate access to money is to create a household budget.  Doing so allows households to understand how money is spent by family members each month on both essential as well as discretionary items.
  • Family Loans:  always an alternative, but sometimes a humbling experience.  Borrowing money from a family member or friend is a good choice if someone has the financial resources, and willpower, to pay back the loan when they receive their tax refund from the IRS.

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