Consumers Union Advises Taxpayers to Avoid Refund Loans (March 2003).

Consumers Can Get Quick Refunds Without the High Cost of Tax Loans

Consumers Union, the nonprofit publisher of Consumer Reports, is advising consumers to steer clear of refund anticipation loans (RALs), which are being widely marketed this tax season. RALs are short-term cash advances that provide cash against a customer's anticipated income tax refund. But the loans are offered at high interest rates and speed up refunds by just a week compared to what consumers can expect by filing online and having their refunds deposited directly into their banking accounts.

"Refund anticipation loans can dock consumers' actual tax returns significantly by charging 98 to 2000 percent annual interest rates," said Rob Schneider, senior staff attorney at Consumers Union's Southwest Regional Office. "Seasonal lenders cash in on the high interest refund loans -- consumers, on the other hand, who have already paid a fee for the tax return, pay excessive rates."

The cash advance is the amount of the anticipated tax refund less a fee, which is retained by the business making the advance. In the event of a mistake with the tax filing, the consumer is responsible for any discrepancy between the amount of the loan and the actual refund.

H&R Block, which is marketing its refund anticipation loan product aggressively, notes on its web site that RALs allow tax filers to get their refund checks in two days. If the same consumer filed her taxes electronically and had her refund deposited directly into her bank account, she would receive the funds in as little as ten days. In other words, the consumer pays a high fee to receive her refund eight days earlier.

According to a recent report by the National Consumer Law center (NCLC) and the Consumer Federation of America (CFA), the fee for a loan for a $1,980 tax refund, the average federal tax refund in 2002, is $75. Including an additional average electronic filing fee of $40, the interest rate on such a transaction calculated as an annual percentage rate is 222.5 percent.

"Refund anticipation loans have rates far higher than many credit card companies charge for similar short-term transactions," said Schneider. "Consumers would be better served dipping into their credit card account to cover expenses while waiting on tax refunds than by borrowing through a refund anticipation loan."

Consumers Union notes that these high fees are especially egregious since a large number of refund anticipation loans are taken out by low income tax filers. An estimated forty percent of consumers who get RALs receive the Earned Income Tax Credit, one of the federal government's largest anti-poverty programs. About $363 million from the Earned Income Tax Credit will be used to pay refund anticipation loan preparers. This amount does not include the fee these filers pay to have their taxes prepared.

Low and moderate income taxpayers with incomes of $34,000 and below can avoid these high fees by taking advantage of free tax preparation services available through the Volunteer Income Tax Assistance (VITA) program. The IRS has trained VITA volunteers equipped to prepare and file tax returns electronically. VITA program sites are located in neighborhood libraries, shopping malls, and community centers. Taxpayers can locate the nearest VITA site by calling the IRS at 1-800-TAX-1040 or 1-800-829-1040.

"Using free tax preparation services is a surefire way for low and middle income taxpayers to avoid excessive rates and stilted fees," Schneider said. "Going through reliable free services can also insure consumers they will get the full benefit of the Earned Income Tax Credit and take home more of the refund they deserve."