Last year saw the advent of “Gray Thursday” and our Congress’ second full year without a budget. What do both of these very different things have in common? In my opinion, they indicate what I think all of us would agree with – that we live in an “I need it now” society. We don’t like to wait. We want what we want, and we want it now. It’s become an American consumer mantra of sorts. We can’t wait until the day after Thanksgiving to go shopping and our government can’t agree on the most basic of fiscal measures to reign in our spending. This tax season, there’s an option out there that’s become popular for the same reasons that we can’t stay out of Walmart on Thanksgiving. Refund Anticipation Loans offer the promise of a tax return as early as January. They’re popular, but are they a good idea?
What are Refund Anticipation Loans?
In my opinion, and I’m in good company, Refund Anticipation Loans are not a good idea. Before I get to why RALs should be avoided, I’ll cover what they are. It may seem like common sense, especially if you’ve really never heard of Refund Anticipation Loans, but they are loans. They are not instant tax refunds and you don’t have to accept them from professionals who prepare your tax returns, either. RALs are high-cost, short-term loans for consumers that are secured by their expected federal and state tax refunds. They sprang up in the 1980s when the IRS introduced electronic tax filing and have hung around ever since. I suspect that most people who take advantage of Refund Anticipation Loans don’t fully understand what they are or how they work.
Why They Aren’t Worth the Fees
When you agree to a RAL, whoever prepares your taxes lends you the amount of your tax refund less interest and fees, which are usually at least $50, for the loan. Just how much you pay in fees and interest depends on who you go with but many people end up giving up 10% of their refund for the convenience and immediacy of a Refund Anticipation Loan. So if you are due a $1,500 refund from the government, you may end up receiving only $1,350. That may not seem like much but I can think of a lot of better things to do with $150 (like go out on a few date nights or buy a few weeks worth of groceries) than give it to a glorified loan shark.
Like Payday Loans, RALs are Risky and Indicate Poor Planning
Refund Anticipation Loans are for taxes what payday loans are for paychecks. Payday loans carry a risk of falling into a vicious debt cycle that never allows you to receive your full paycheck and RALs carry a risk of never allowing you to receive your full tax refund. They meet the need for immediate income but come with a cost. Like Payday loans, RALs are risky. The New York Department of Consumer Affairs lists RALs as one of the five types of loans to avoid. While they are called “instant refunds” they are actually high-interest, fee-loaded loans. When the administrative and lending fees are totaled, RALs can carry an annual interest rate of 300%.
As anyone who’s filed their own taxes knows, it’s easy to make a mistake and overestimate your return. If you select a Refund Anticipation Loan, you end up owing, with interest, any difference between your anticipated and actual refund. If you take a RAL and are expecting a sizable return and that return ends up being much less than you anticipated, you and not the person who prepared your taxes could be liable for a large amount of money. Ultimately, Refund Anticipation Loans indicate a lack of proper planning. If you plan ahead and optimize your tax withholdings you can end up with a smaller tax refund, which is better in the long run because it gives you more money to spend throughout the year.
Wise Alternatives to Refund Anticipation Loans
Instead of Refund Anticipation Loans, taxpayers have other, wise and convenient options, like E-file and E-deposit. When Mrs. Frugal Rules and I both used to work for employers instead of being self-employed, we filed our income tax return online. For years, I used online tax filing and had our refund deposited directly into our checking account. The process of filing taxes online took 7-10 days. RALs take 1-3 days; in my opinion, it’s worth it to wait an extra week to get all of my refund instead of only a portion of it.
My Personal Experience with a RAL
If you’ve taken out a Refund Anticipation Loan in the past, don’t feel bad. We all learn from our mistakes. In the first year that Mrs. Frugal Rules and I were married, we were expecting a huge tax return in the neighborhood of $5,000 and were planning a cross country move. I decided to take out a RAL so we could access our tax refund money faster. I knew we were losing money to fees but at that point in time, it was a cost I was willing to pay. I was a different person back then and have learned much in the past decade about the importance of living with a budget, living within my means and planning ahead when it comes to personal finances. Today, I E-file and try to limit my refund so that it’s as small as possible because I know that means more money for my family to live on throughout the year.
Have you ever used Refund Anticipation Loans or are you planning to this tax season? If so, what was your experience with them? Were they worth it?
Photo courtesy of: Matt Aiello