Beware the Tax Refund Loan
Tax preparation software firms, in cooperation with the IRS, are this year again offering free online completion of federal returns–to filers with adjusted gross income of $52,000 or less. But there's one new missing ingredient.
Refund anticipation loans will no longer be offered–to the applause of consumer advocacy groups, the IRS's taxpayer ombudsman, and even IRS Commissioner Mark Everson.
That extra-cost option lets you quickly pocket an expected refund by taking out a short-term loan in the amount of the refund and using later actual refund money to pay back the loan.
Financial planners, tax advisers, and consumer activists regard the loans mostly as a terrible deal. The time saved over waiting for a regular refund when filing electronically may be only about two weeks or so, and the cost can be high–an annual interest rate of 400 percent and up in some of the worst cases. It's often people receiving the earned income tax credit and others who can least afford the nick off their refund or who don't have a bank account for direct deposit who succumb to the sales pitch.
Promotion of the loans in an IRS-sanctioned program appeared unseemly to critics, even though few people have actually taken them out when using the free file program (check the IRS website starting January 16: www.irs.gov). Nevertheless, under pressure from critics, the coalition of firms offering the free filing agreed to drop the online lending.
The loans are much bigger sellers when pushed face to face in a tax preparer's office and are widely offered by H&R Block, Jackson Hewitt, and other big and small firms. But the programs are often misleadingly or incompletely described, according to government and other reports.
Investigators for the Government Accountability Office said one preparer asked that a loan application be signed at the start of the visit without explaining what it was, and another never clarified that the speedier "refund" cost extra and wasn't a benefit included in the standard price of preparing the return.
Block, for one, has announced lower costs and other reforms for this year.
Some attacks may be overly nannyish. Interviews over the years with loan clients found some who felt misled but others who were satisfied to pay perhaps $100 to $150 for an instant payoff of possibly $1,500 to $2,000, the annualized high interest notwithstanding. A study done at Georgetown University concluded that many borrowers know what they're getting into, like the option, and do not need protection from themselves.
Mathematical reality dictates that short-term loans of this sort are susceptible to a high annual interest rate since the cost of providing the loan must be recovered over not a year but a few weeks.
But it's true that borrowing charges on top of fees for tax preparation, electronic filing, and other incidentals can make impatience expensive. The less the refund, the worse the deal generally is because fee structures can severely punish smaller refund loans.
The National Consumer Law Center, a critic of the loans, says potential borrowers can instead ask the IRS to directly deposit their refund into a bank account to speed receipt–and if they don't have an account, they should consider opening one as good money management.
Nannyish or not, the consumer group says the question for anyone is simple: "Do you really have to get cash from a refund today? Can you wait a few weeks?"
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