E-filing can make high-fee loans unnecessary

Who would pay an annualized rate of 178 percent on a 10-day loan they are essentially making to themselves?

Apparently over 12 million taxpayers would, according to the National Consumer Law Center. That is how many taxpayers took out a refund anticipation loan, or RALs, in 2004. Though these loans are more often referred to as "instant tax refunds" by the tax preparation firms that market them.

Obviously it is the promise of speed that attracts taxpayers, not the fine print. 

“The amazing thing about the popularity of these loans is that people are paying triple-digit interest to get their refunds back only a few days earlier,” says Gail Cunningham, vice president of business relations for Consumer Credit Counseling Service of Greater Dallas.

Opting to pay a ‘convenience fee’ that would make even a loan shark blush may almost have made sense when paper-based filing and snail-mailed refund checks ruled the day.  But those days are quickly fading to memory for the majority of taxpayers.

“Last year more individual returns were filed electronically than by paper and more refunds were returned through direct deposit than through the mail,” says Eric Smith, spokesperson for the IRS in Washington, D.C.  The upshot? Most refunds are received within two weeks. 

“These taxpayers have gone all year without the money — money they unnecessarily overpaid to the government to begin with — and suddenly they are in a hurry to get it back,” observes Cunningham.  “But even a cash advance on a credit card is more attractive than a RAL at these rates if they are that hard up for cash,” she adds.

So what is the rush?  The guess of consumer advocates is that it is not necessarily an instant need that drives the demand for RALs, but a lack of understanding that ‘instant refund’ really means a ‘loan against your refund.’

Even more alarming than so many taxpayers opting to spend money to get their hands on their own cash a few days earlier is that the majority of RAL recipients — 7 million of them in 2004 according to the NCLC — claim the earned income tax credit. These are the taxpayers least able to afford the ‘vig’ on the rapid return of their money, not to mention the tax preparation fees that are often deducted from these instant refunds.

Those tax prep fees are often as avoidable as the RAL fees since these same taxpayers qualify for the IRS’s free tax preparation programs and e-filing. The IRS’s Free File Alliance program provides free Web-based electronic filing for those taxpayers with annual adjusted gross incomes of  $50,000 or less. Free in-person tax help is also available through the VITA program for low-to-moderate income taxpayers and TCE (Tax Counseling for the Elderly). Information on both programs may be found by calling 1-800-829-1040. 

Many RAL borrowers are also among the 35 million ‘unbanked’ Americans. These taxpayers may not only be incurring borrowing and tax prep fees unnecessarily they may also be paying an additional 3-7 percent fee to cash their ‘instant’ refund checks since they lack bank accounts.

Seemingly influenced by the growing chorus of complaints by consumer advocates such as Cunningham, some RAL lenders came up with a ‘compassionate’ response: Disbursing their RAL proceeds in the form of a prepaid debit card.  This does not address the usury-like lending costs, but it does save ‘unbanked’ borrowers from the subsequent check-cashing fees. 

However, these debit cards typically incur shipping and handling fees. Then there may be a usage fee every time the debit card is used at a store or ATM. Some issuers tack on a monthly fee if the card is still active after a few months. Others charge an inactivity fee if the card is not used regularly each month.

The debit cards may reduce overall fees, and they are certainly more convenient than walking around with a couple thousand dollars in cash.  But using a refund check — instant or not — to open a bank account that has an ATM/debit card attached to it is significantly cheaper.  And it is often fee-free.

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