Instant tax refund loans are bad: Before the IRS implemented an e-file tax return system in the 80s it would take months to get a refund check. You had to wait for your file to reach the IRS through the mail, wait for them to process and vet the documents, and then wait for your return to come to you through the mail.
Enough people were frustrated by this system that by the time e-filing came along desperate people were willing to pay to get their refund early. Companies took advantage of this desperation and began offering Refund Anticipation Loans or a Tax Refund Loan.
These were some of the most usurious loans on the market. Here’s why they’re still a terrible idea.
1. What’s a Tax Refund Loan?
A Tax Refund Loan is a loan on your individual tax refund. It’s not unlike a payday loan. You get your tax refund before the IRS issues the refund. But it’s still a loan.
In the 70’s, when electronic money transfer made fairly quick refunds possible, loan companies offered high-interest loans on tax refunds. These loans were based on an estimate. Often these estimates were lower than the actual refund.
Not only were loan companies making a profit off the interest and loan fees, they were keeping the underestimated funds. It was purely a scam.
The IRS later found that almost 90% of customers who took advantage of the loans were low-income filers. And the Earned Income Credit actually increased the number of people caught in this nasty trap.
Many didn’t take into account outstanding debt to the IRS itself. Often taxpayers found themselves without a refund and owing two masters. The tax refund loan that seemed like a savior was actually financial damnation.
The IRS Banned Crooked Anticipation Loans
The last lender to fun these kinds of tax refund loans was the Republic Ban and Trust. In 2012 they charged a $61.22 fee for a $1,500 loan. And the interest rate charged 149% annually.
Of course, these were designed to be short-term loans paid off quickly, but sometimes filers couldn’t afford to pay back the loan. The National Consumer Law Commission found that about $465 million dollars of the Earned Income Credit were going to pay back interest on tax anticipation loans.
Essentially, the government was paying into a scam. Thus the IRS began to fight back in 2010. It announced it would no longer issue debt indicators.
Lenders used debt indicators to determine if someone was eligible for an anticipation loan. Without indicators, it was more costly for lenders to determine eligibility. Eventually, all banks ceased lending anticipation loans.
2. But I Googled “Tax Refund Loan” & Found They’re Available
The advanced loans available today are a shadow of the anticipation loans of the past. While some tax preparers offer an advance on your refund, they don’t charge interest or fees on the actual loan.
With e-filing now available, loans get repaid quickly and thus the tax preparer isn’t as liable as a bank would have been in the past.
While these loans aren’t as costly to consumers as the previous versions of this kind of loan, it’s still a sticky way to deal with money that’s rightfully yours. The lender does not pay the advance in cash. You instead receive a prepaid debit or credit card.
These prepaid cards often involve hidden fees. What’s more, the tax preparer still has to prepare your taxes. They’re not going to do this for free. They shave off a portion of your refund to pay for their services.
3. Alternatives to a Tax Refund Advance Loan
According to the IRS, the average tax refund in 2018 was almost $3,000. While that seems like a lot of money, and you might feel like you need it now, is it worth giving away more money for immediacy?
There are a few things you can do instead of getting a loan on your tax return. Here are a few.
1. Go Electronic
Some tax preparers still insist on filing via mail. They claim that filing online risks stolen information. Don’t give in to the paranoia.
A tax preparer is liable for your information and so is the IRS. It would be a disaster if these entities lost your information. Thus, e-filing is one of the most secure systems in the world.
How is going electronic better than a loan? Not only do you avoid stuffing your money into a pre-paid card, you get your refund just as fast as you’ll get the loan.
Loan applications take just as long as a refund. You’ll waste precious time and resources to securing the loan. And again, you will be unable to use your full refund.
2. Use Direct Deposit
If you can afford a bank account, you should opt for direct deposit. Even when e-filing, a mailed check could take an extra 11 days to reach you. This is after your refund has cleared at the IRS ten days later.
Would you rather get your money 21 days later or 10 days later? And what if your check gets lost in the mail? Direct deposit is insurance against that, and the fastest way to get your refund. It’s even available in the free edition of top brands like TurboTax.
3. In-Store Financing
Whether you’ll use this depends entirely on what you plan to use your money for. If it was for a new appliance, you will likely find a store willing to finance your purchase with no interest for a time.
Sometimes, stores will even give you credit toward a purchase. You can pay off the credit when your refund comes in.
Wisdom Over Speed
You don’t have to put yourself into debt to survive. There are always alternatives. Be wise and do your research.
If you’re looking for tip and tricks to help you save this tax season, check out our advice on how to use online tax services to your advantage.