When you expect a refund from the IRS, time seems to slow to a crawl. No matter how badly you need your cash back, it can feel like you have to wait forever for the government to process your tax return, figure out how big your refund is, and get your money back to you. Even if you file electronically and elect to have your refund directly deposited in your bank account, the three weeks that the IRS has as its goal to get the majority of refunds back to taxpayers can still be a long time.
For taxpayers who are in a hurry, there are financial institutions that are more than willing to help you bridge that short period between when you file your tax return and when your refund comes. What many taxpayers don't understand, though, is the true cost of taking advantage of the services that these institutions provide. Despite past regulatory efforts to get rid of these taxpayer traps, refund anticipation loans are back -- and they can cost you a lot more than they're worth.
The history of refund anticipation loans
Refund anticipation loans initially got a bad reputation because of the fees and other costs that they imposed on taxpayer borrowers. Financial institutions would offer to pay you most or all of your anticipated refund amount when you filed your tax return, charging you an application fee. Then, the institution would get repaid when your refund check arrived.
The problem with these programs was that the size of the fee was disproportionately large compared to the size of the loan. Given that the term of the loan was so short -- often just a matter of weeks -- those fees translated into triple-digit annual percentage rates. Fortunately, due to efforts from the Consumer Financial Protection Bureau and others, traditional refund anticipation loans largely disappeared from the financial services landscape.
For a while, providers of refund anticipation loans changed their tactics, offering no-fee variants of their services. Often, these no-fee arrangements came with strings attached, commonly including the requirement that the taxpayer use a particular tax preparer and pay for associated tax services. Indeed, major providers like H&R Block, Jackson Hewitt, and Intuit's TurboTax had no-fee refund advance products available for brief periods of time earlier this tax season.
Yet this year, some costlier alternatives are back, according to the latest report from the National Consumer Law Center. One option for taxpayers is to receive refund anticipation checks, which offer unbanked taxpayers a way to access refunds through opening a temporary bank account and then arranging for funds to get transferred via direct deposit, a check, or a prepaid card. Providers can tack on extra fees for these disbursements, which typically end up having the net impact of advancing only the amount of the tax preparation fee that the affiliated preparer charges.
In addition, some financial institutions are once again offering refund anticipation loans with interest rates of 24% to 45%. Even those high rates, however, don't necessarily reflect the full impact of other fees on the effective rate of interest that taxpayers have to pay, such as origination and application charges.
Be patient and save
As annoying as it is to have to wait for a tax refund, the charges associated with getting an advance on your refund amount are a huge trap that snares too many taxpayers. The better choice is simply to do everything you can to speed up your refund the regular way.
Electronically filing your return will save weeks in potential mail delivery delays and the longer IRS process of handling paper returns, accelerating your refund dramatically. Arranging for direct deposit will save a week or two by keeping the IRS from needing to prepare a physical refund check and mail it to you.
Most people think of tax planning as what happens before you file your return. But with the potential threat to taxpayers from lending institutions, doing some planning to bridge the gap between when you file and when you get your refund can be even more important to your financial health.