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
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:
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:
Note: Annual 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%.
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:
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