Why Tax Refund Loans – and Tax Refunds Themselves – Usually Make Bad Financial Sense

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Many consumers understand that loans based on anticipated refunds from the IRS – also known as “tax refund anticipation loans” or “tax refund advances” – are a bad idea. What most taxpayers do not realize, though, is that the strategy of relying on a big tax refund check from the IRS year after year is also unwise. First let’s examine why using a future tax refund as the basis or collateral for a short-term loan is a money-losing proposition. Then we’ll look at reasons why waiting for your tax refund every year may also be a habit you need to eliminate or at least revise.

Why Refund Anticipation Loans are a Rip-Off

Lenders who make refund anticipation loans typically charge super-high interest rates and fees. The price you pay for getting your money a week or two earlier doesn’t justify the cost because the interest rates typically add up to 300% or more on an annualized basis. Even the most outrageously expensive credit cards, by comparison, typically charge less than 10% of that amount.

Federal regulators and state officials filed so many lawsuits against this kind of lending practice -alleging that it amounted to predatory lending- that almost all of these tax refund loans are no longer offered. Here are a few examples:

  • In 2006, for example, the Attorney General of California filed a lawsuit against H&R Block. The complaint alleged that the tax preparation company did not do an adequate job of disclosing the actual fees and interest charges associated with its refund anticipation loans.
  • In 2011 federal regulators forced HSBC bank to discontinue its handling of those particular loans. Soon other banks and nationwide tax preparation companies heeded the warning and got out of the business of offering refund anticipation loans.

As long as there are taxpayers impatient to receive their IRS refund money, however, there will be lenders trying to use that as leverage to sell high-interest cash advance products. Just as expensive payday loans are ill-advised, so are loans based on tax refunds. Don’t succumb to the temptation because it is a losing proposition that simply reduces the amount of your hard-earned refund.

How to Expedite Your Refund

The IRS generally does a good job of getting refunds delivered promptly, and last year approximately 90% arrived in less than three weeks from the date tax returns were received. Here’s how you may speed up this process:

  • Filing quickly, rather than waiting until April 15th, and filing electronically instead of by mail is the best way to ensure that your refund comes without delay.
  • To accelerate the process even more, have the IRS use direct deposit to wire your refund into your bank account – versus using “snail mail” to send you a check or pre-loaded credit card. You can also direct deposit your refund into your IRA account, if you prefer.
  • You can divide your refund across two or more accounts. For example, you can have part of your refund sent to your IRA, another portion deposited in a savings account, and the rest directed into your checking account. You will need to fill out an IRS Form 8888 for that to happen.

Tax Refunds are not a Bonus From the IRS

One strategy to avoid the tax refund process completely is to estimate out your taxes more accurately. This also saves you from falling victim to identity theft or tax refund theft because you’re avoiding the mail altogether. The only reason the IRS sends out refunds are when the taxpayer has paid more than necessary, but many Americans forget that basic fact. Instead they just take it for granted that every year they will pay money to the IRS that they may not owe, and then wait around for it to be refunded back to them. Then when the refund arrives they celebrate as if the IRS has given them some kind of generous bonus.

For example, nobody walks into a store and deliberately pays $50 for a $40 shirt, and then waits for the merchant to send them a $10 refund check in the mail. Just attempt to plan your tax withholding's more carefully so you don’t withhold more than is necessary. You will need to fill out a new W-4 through the HR department. One tax expert suggests increasing your exemptions by 1 for every $1,500 you get back.

I can understand the convenience of letting your employer automate everything, file when it’s time, then wait for the return because all the hard work is in their hands, not yours. It is more time consuming too, so you should really consider how annoying it is to wait for a return vs. estimating the amount you will owe ahead of time.

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