Refund anticipation loan (RAL) is a short-term consumer loan in the United States provided by a third party against an expected tax refund for the duration it takes the tax authority to pay the refund.
The loan term was usually about two to three weeks, related to the time it took the U.S. Internal Revenue Service to deposit refunds in electronic accounts. The loans were designed to make the refund available in as little as 24 hours. They were secured by a taxpayer’s expected tax refund, and designed to offer customers quicker access to funds.
The costs to the borrower could be significant compared to other lending and some consumer organizations warned consumers of the risk involved in this type of loan. They are a largely discontinued financial product and beginning with the 2013 tax filing season, they have been largely replaced with the similar refund anticipation checks (RAC), as well as a hodge podge of other financial products.
RACs are temporary accounts which wait for the client’s IRS tax refund, and which also provides a way for the client to pay for tax preparation out of the refund. Both financial products have similar fees and similar risks of third-party bank “cross-collection”.
How a Tax Refund Anticipation Loan Works
When individuals file their income tax forms for the year, they may find that they are entitled to a tax refund. Tax refunds return the excess amount of income tax that a taxpayer has paid to the state or federal government during the past year, typically through withholding from a paycheck. In the United States today, the majority of taxpayers receive income tax refunds.
The U.S. Treasury issues refunds in the form of government checks, U.S. savings bonds, or direct deposits to the taxpayer’s bank account, depending on what the taxpayer has requested. Most refunds are issued within a few weeks after the taxpayer submits his or her tax return for the year to the Internal Revenue Service (IRS), the bureau of the Treasury Department that is responsible for collecting taxes. Direct deposit is generally the fastest method to receive a refund.
A tax refund anticipation loan (RAL) is marketed as way for the taxpayer to receive his or her money even more quickly. Such loans are not provided by the U.S. Treasury or the IRS, but by third-party companies, and they are subject to the interest rates and fees set by the lender. Tax refund anticipation loans are most often offered by large tax preparation companies to taxpayers who are expecting refunds of a few thousands dollars or less.
The government pays most tax refunds within a few weeks, so taxpayers who don’t need their money immediately gain little benefit from a refund anticipation loan.
Pros and Cons of a Tax Refund Anticipation Loan
With a tax refund anticipation loan, an individual can get quick access to a sum of money based on his or her expected tax refund. But because taxpayers will typically receive their refunds from the government within a few weeks, anyway, borrowing that money usually makes little financial sense, unless the taxpayer is in immediate need of the funds.
A major reason is that refund anticipation loans can be a very expensive form of borrowing, especially considering the short-term benefit they provide. If the lender charges interest, the quoted rate may seem small, generally around 3% to 5% of the refund amount. However, the total cost can be much higher when additional fees and charges are factored in. While many people see a tax refund as forced savings or a nice bonus at tax time, they might want to view it another way. That is, the bigger their refund, the more money they have been lending to the government, tax free, during the past year.
As an alternative, taxpayers might consider adjusting their federal and state tax withholding so that their employers withhold enough money from their paychecks to cover their likely tax obligations for the year, but not so much as to produce a large refund. By doing that, taxpayers who have the discipline to save that extra income can put it aside for future use, possibly eliminating the need to even think about a tax refund anticipation loan.
According to the Consumer Federation of America and the National Consumer Law Center, RALs are controversial because, like unregulated payday loans, RALs are high-profit, low-risk loans marketed toward the working poor. Opponents of RALs, like the National Consumer Law Center, argue that the profit motive of the lender results in RALs being issued too often to low-income individuals who are made to believe the wait for their refund is longer than it really is, who do not realize they are taking a loan, do not understand the high interest rates charged by the loan (often exceeding 100% APR until the last two tax filing seasons), and who do not actually need the funds immediately.
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