Financial Education
Beware Of Tax Refund Loans
Scott Reeves, 02.13.06, 6:00 AM ET

NEW YORK - How much would you pay to borrow your own money?

The smart consumer will shout, "Zero! Zilch! Nada!" but millions of
Americans pay a stiff fee just to grab their federal tax refund a few days
early with a "refund anticipation loan."

"The people who can least afford it sign up for these loans," says Gail
Cunningham, vice president of business relations for the nonprofit Consumer
Credit Counseling Services of Greater Dallas. "Adjust your withholding, talk
to your landlord or borrow from your mother--almost anything is better than
one of these loans."

The pitch for a refund anticipation loan is simple: speed and convenience.
But a little planning can keep the fee charged for such loans in your
pocket. Remember that a refund anticipation loan is a short-term advance on
your own money and one of the most expensive ways to borrow.

Here's how a refund anticipation loan works:

At the tax preparer's office, the taxpayer signs a form authorizing the IRS
to deposit his refund in the lender's account. The taxpayer receives the
refund up front, less a hefty service charge. The taxpayer's anticipated tax
refund secures the loan. After the return has been processed, the IRS
deposits the taxpayer's refund into the lender's account.

Such loans are gravy for the tax preparer. Refund anticipation loans
typically include $30 to $115 in loan fees. Some tax preparers add an
"administrative" or "application fee" of $25 to $60 and a few charge a
special fee to file the return electronically. Given the short term of such
loans, the effective annual percentage rate can hit triple digits.

There are no precise figures on the number and total cost to consumers of
refund anticipation loans. But using IRS figures and bank reports, Chi Chi
Wu, a staff attorney for the National Consumer Law Center in Boston,
estimates that the 10 million refund anticipation loans issued in 2003 cost
consumers about $1 billion, or an average of $100 each.

If you file your return electronically, you can expect a return in about
three weeks, and if you sign up for direct deposit, you should have the
money in ten to 14 days. So, a refund anticipation loan doesn't get the
money in your hands significantly faster than waiting for reimbursement from
the IRS.

Such loans make no sense unless your have no cash or credit reserve and are
about to starve. So, for most people, there is no reason to sign up for a
refund anticipation loan.

But after getting bitten once by such a refund anticipation loan, it's
possible to get bitten again. The loan must be repaid, even if the
taxpayer's refund is smaller than anticipated, denied or frozen as part of a
divorce settlement. You can bet that any shortfall to the lender is hit with
a hefty interest charge to the borrower--it's all right there in the small
print no one reads.

If the taxpayer doesn't repay the loan, the lender may turn it over to a
collection agency. That will almost certainly show up on your credit report,
prepared by Equifax (nyse: EFX - news - people ), Experian or Trans Union,
and damage future applications for credit and a home or auto loan at major
banks such as JPMorgan Chase (nyse: JPM - news - people ), Wells Fargo
(nyse: WFC - news - people ) or Citigroup (nyse: C - news - people ).

Refund anticipation loans are sold under names such as "Refunds Fast," "Fast
Cash," "Express Money" or "Instant Refunds."

If you plan to spend your refund immediately and just can't wait for that
new stereo, TV or refrigerator, check into store financing. Many large
retailers offer low or no interest and fees for the first 30 to 90 days. As
always, read the contract. (See: "Seven Things To Do With Your Tax Refund.")

In December, H&R Block (nyse: HRB - news - people ) agreed to pay $62.5
million to settle four class-action lawsuits dealing with its use of refund
anticipation loans. The deal will cover 8 million customers who got the
loans between 1989 and 2005.

Critics charge that the loans prey on low-income and unsophisticated
taxpayers who don't fully understand the cost of the loan. H&R Block says
all fees are disclosed and a chart shows less costly alternatives to a
refund anticipation loan.

"If people need the money right away, they need to be aware of alternatives
so they can make an informed decision," says Linda McDougall, a spokeswoman
for H&R Block in Kansas City, Mo.

Some taxpayers intentionally over-withhold as a forced savings plan. It's a
bad idea because you're giving your money to Uncle Sam interest free for a
year. (See: "Getting The Basics Right" and "Withholding.")

For many, tax season is the time to split a dozen pencils into kindling. Tax
preparation software helps and a good tax pro, while far from cheap, can
save you money by taking all applicable deductions and preparing your return

It's never too early to start thinking about how you can save money on next
year's taxes. (See: "Getting A Jump On Tax Season.")

But whatever you do this year, don't sign up for a refund anticipation loan.