Tax Refund Loans – Costs & Alternatives
March 16, 2010
Tax refund loans, also known as refund anticipation loans or fast tax loans, can be a tempting option if you’re in need of money and expecting an IRS refund. However, these tax refund loans can be a very expensive option due to the fees and interest charges that typically accompany them.
Refund Anticipation Loans
The official name of these loans is refund anticipation loans, or RALs. The Consumer Federation of America lumps RAL loans in with their more notorious cousin payday loans due to the high fees associated with them.
A February 2009 report indicated that RAL loans generated an estimated $900 million in fees from 8.67 million taxpayers who used them based on 2007 figures alone. These services promise your refund money immediately or in a few days (less fees and costs), but if you’re willing to wait an extra couple of weeks, the Internal Revenue Service will pay back your refund without fees or interest charges when you file IRS Form 8888 with your return.
The IRS option also makes it relatively simple to divert your refund into an IRA contribution or the purchase of U.S. Treasury securities or U.S. Savings Bonds.
Costs of Tax Refund Loans
In 2007, the Consumer Federation and the National Consumer Law Center reported that RALs cost the average borrower from about $30 to more than $125 in loan fees. Some tax preparers also charge separate fees on top of those amounts for the “application.”
In their study, both agencies reported that the effective annual interest rate (APR) for a RAL can range from about 40 percent to over 500 percent, and if application fees are charged and included in the calculation, the effective APRs range from about 57 percent to over 1,100 percent.
Tax Return Tips
The real point is that it’s important for you to try and plan your finances and tax strategy so that you’re hopefully not scrambling in need of a tax refund in April. Most financial planners will you that the best way to put cash in your hand is through tax planning, not overpayment of tax so you can get a check later.
Want to put extra money in your pocket all year round, not just at tax time? Consider the following steps:
Qualified tax professionals such as certified public accountants (CPAs), enrolled agents (federally licensed individuals who have passed a comprehensive IRS exam) or a tax attorney can help you devise a strategy so you and Uncle Sam don’t owe each other anything at tax time.
You’ll do this through smart withholding and finding legal deductions that might create tax savings. Many individuals can get by with the help of an enrolled agent or CPA, and while there are many tax attorneys who do individual returns, they are typically used for business returns or more complex individual tax situations.
Restructure your spending:
Understanding your spending will prevent you from looking desperately for cash at other times. A financial planner can give you some critical advice in building a budget that fits you and your income and spending picture.
You can also buy a financial tracking program like Quicken and start typing in your daily spending (that could be a real eye-opener). Once you know what you’re spending, you can figure out how to afford essentials and extras in a way that will prevent a panicky search for money around tax time.
Make smart money choices:
Quit thinking about your refund as an excuse for a trip to Home Depot. Why not use an unexpected tax refund to fund an IRA or some other savings or investment vehicle? If you finish your taxes early enough you might be able to deposit that overage directly in those accounts.
To help you understand why tax refunds call out to you to be spent check out the parts about mental accounting in the book “Why Smart People Make Big Money Mistakes”. If you understand the reasons why our brains like to use mental accounting it can help you overcome irrational money behavior and make better money choices.
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All posts by Ben Edwards