Would you agree to accept a loan that carries 149% APR? Of course not. Any consumer who has the least bit of financial sense knows that this is a potentially devastating loan to take. Except that’s exactly what they do during tax time and they want their refund quick, fast and in a hurry. Most of the time, tax payers don’t even realize that they have taken out such a dangerous loan.
They get suckered into their tax preparer’s offer of fast money in the form of a Refund Anticipation Loan (RAL) without even bothering to consider that the fees charged for this quick cash can climb as high as a 521% APR. For a tax payer who is already under serious financial constraints, this is simply a time bomb waiting to explode.
A RAL works like this:
A tax payer files his taxes through a tax preparer.
If a refund is due, the tax preparer offers to loan the tax payer an amount equivalent to his refund so he doesn’t have to wait the full 10 day period to receive the money from the IRS.
The loan is repaid when the IRS sends the refund directly to the tax preparer.
Sounds okay so far.
Here’s the not so okay part. The tax preparer tacks on so many fees for the service that the effective APR shoots into the triple digits and eats up a sizeable chunk of the refund before the tax payer can even get a whiff of it. The really sucky part? The loan is based on an estimate. If the IRS only returns part of the refund, the tax payer is still on the hook to repay the balance of the loan out of his own pocket. Since the majority of tax payers who accept these loans do so because they are cash strapped, this practice effectively digs them into a much larger financial hole.
Thus far, these lenders have been able to sidestep usury laws, however, consumer advocates and the government itself have taken note and are taking steps to shut down this predatory lending practice.
The IRS encourages consumers to avoid these loans at all costs. Although, the IRS has no authority to regulate refund anticipation loans, they’ve taken strides to make the loans less attractive to lenders. In mid 2010, they announced that they will no longer provide the tax payer’s debt indicator to refund anticipation loan lenders. This makes the loans super risky because the bank will have no way of knowing if they will receive the full repayment from the IRS or if the tax payer’s refund will be garnished to pay outstanding student loans or child support.
In addition, the IRS has made an effort to drain the demand for these loans in the form of a program where they send out refunds on a pre paid debit card. The initial sample is 600,000 tax filers. The hope is to provide a faster, cost effective alternative for low and moderate income families who do not have bank accounts into which the IRS can refund the taxes via direct deposit.
Granted, neither option will completely obliterate the predatory practice of refund anticipation loans. There will also always be circumstances where such a loan could turn out to be a blessing since God does everything for our good. Still, it’s a good idea to educate yourself about the reality of these loans before agreeing to take one on. Or better yet, borrow the slogan from the war on drugs campaign and “Just Say No.”