Refund anticipation loans coming to an end
Consumers who rely on quick refunds still have plenty of options
Offers of quick cash at tax time come at a high price for millions of consumers each year. But federal crackdowns on banks mean once such source -- refund anticipation loans (RALs) -- might be on the way out.
"It's pretty much the end of the RAL as big business," says Chi Chi Wu, staff attorney for the National Consumer Law Center (NCLC), which has tracked -- and criticized -- refund anticipation loans for more than a decade. "The business model we saw before is going to be gone."
Experts say, though, that consumers who relied on these quickie tax loans have plenty of options that will allow them to get their money fast -- and keep more of it.
RALs: loans, not fast refunds
The business model that made refund anticipation loans so lucrative for tax preparers and banks -- in 2009, according to the NCLC and the Consumer Federation of America (CFA), 7.2 million consumers paid more than $606 million total in fees on refund anticipation loan fees -- also led to its downfall.
Consumer groups say that's because tax preparers were acting as agents for banks, but often failed to comply with federal regulations and state laws -- a fact that was uncovered over and over by government investigators, as well as mystery shoppers hired by consumer groups. "There was a failure to tell people what a RAL really was and to make disclosures," Wu says.
For example, according to an NCLC/CFA 2011 report, "End of the Rapid Rip-Off: An Epilogue for Quickie Tax Loans," some tax preparers put up storefront signs falsely advertising these loans as "instant" or "same-day tax refunds."
In fact, a RAL is not a quick refund, but an expensive loan that works like this:
- A tax preparer partnering with a bank or other lender completes a tax return and offers a RAL to the client.
- Within a day or two, the consumer receives a loan -- either for the amount of the anticipated refund, minus the tax preparation fee, the RAL fee and any add-on fees, or for the maximum amount allowed by the lender. (For example, Republic Bank & Trust Company, the only bank still making RALs for tax preparers in 2012, offers a RAL of only $1,500 for a fee of $61.22 -- which, if annualized, translates to an APR of 149 percent.)
- About eight to 15 days later, the IRS deposits the tax refund into a bank account controlled by the refund anticipation loan lender. If there is additional money owed to the consumer, the lender cuts a check, usually charging an additional fee for that service. (For example, Republic Bank & Trust charges about $30 extra.)
- If the refund does not come through -- for example, if it is intercepted by the IRS to pay back taxes, student loans or child support owed -- or if it is not as large as anticipated, the consumer is obligated to pay back the loan and might get hit with late fees and have payment history reported to credit bureaus, Wu says.
"This is very short-term, very high-risk credit that isn't necessary in order to put tax refund money into the bank accounts of consumers in a very short time," says Jean Ann Fox, director of financial services for the Consumer Federation of America.
It's pretty much the end of the RAL as big business. The business model we saw before is going to be gone.
|-- Chi Chi Wu
National Consumer Law Center
However, Nessa Feddis, vice president and senior counsel for the American Bankers Association, says refund anticipation loans have served the needs of some consumers. "There will always be people who need money sooner than the IRS can provide it, even with quick turnaround," Feddis says.
The history of RALs
Taxpayers have always waited eagerly for refunds, but refund anticipation loans only became ubiquitous after the IRS introduced electronic filing and direct deposit for refunds in the 1980s. "Once you had those two things, refunds became much faster," Wu says. "It introduced a very profitable business model."
With direct deposit, Wu says, banks could make a loan to the taxpayer and then have the refund deposited directly into an account controlled by the bank. "When the bank has control [of the refund money], it makes it a very safe loan for the bank," Wu says. "That was one thing that really led to the growth of RALs."
Then, consumer groups say that when the Earned Income Tax Credit, a federal refundable income tax credit for low-income working individuals and families, was expanded in the 1990s, tax preparers saw a way to make even more money by marketing refund anticipation loans as a way to avoid paying tax preparation fees upfront.
"Families with fixed incomes and kids, by the time January rolls around, it's tough for them," Wu says. "Tax preparers and banks saw a business opportunity, and that's when RALs really took off in terms of volume."
At the height of refund anticipation lending in 2004, 12.38 million RALs were made and consumers paid about $1.24 billion in RAL fees just to get money a week to two weeks earlier than they would have gotten their refunds, according to the NCLC/CFA 2011 report.
According to 2009 IRS data from the report, about 87 percent of refund anticipation loan users were low income, and about two-thirds received the earned income tax credit. "That's anti-poverty money that's delivered through the tax system, and throughout the heyday [of RALs], banks and other lenders were diverting that money into their own coffers," Fox says.
In the past few years, though, actions by the IRS and federal regulators have pushed most banks out of the RAL business. In 2010, the IRS stopped offering its debt indicator, which showed a lender whether a tax refund might be intercepted to pay off debts. "It was a form of free credit reporting to help the lender," Fox says.
That same year, one of the largest RAL lenders, JP Morgan Chase, voluntarily decided to stop offering the loans. Then, in late 2010, the Office of Comptroller of Currency, a federal regulator, ordered HSBC -- which provided RALs through H&R Block -- to stop doing so.
By 2011, only three smaller banks were still making RALs. Based on a notice from the Federal Deposit Insurance Corp. that making these loans was "unsafe and unsound" without the IRS debt indicator, two banks got out of the business, leaving only Republic Bank & Trust, which sued the FDIC. However, as part of a settlement with the FDIC, Republic agreed to pay a $900,000 civil penalty and to stop making refund anticipation loans after April 2012. For this tax season, though, Republic Bank & Trust is still making the loans for two large tax preparation chains -- Jackson Hewitt Tax Service and Liberty Tax Service.
As banks are forced out of this line of business, RALs are becoming harder to obtain: Republic Bank & Trust requires consumers have an anticipated refund of at least $2,000 to get a refund anticipation loan, and, according to the NCLC and CFA, many consumers who apply can expect to get rejected.
Beyond refund anticipation loans
Consumers who relied on RALs in the past can still get their tax refunds fast without using these loans, though, experts say. Here are some tips on how to survive tax season without a RAL:
- Get ahead of the tax filing rush. "File as early as possible," says Uriah King, vice president of state policy for the Center for Responsible Lending. "If you e-file very early and do auto deposit into your checking or savings account, you should have your refund within a week."
- If you don't have a checking account, don't worry. You can still get your refund quickly by having it deposited into a savings account or onto a prepaid card. "Half of the so-called unbanked have a savings account," King says. "It is easier to get a savings account than a checking account."
- If you use a prepaid card to get your refund, shop carefully. You can get your refund on any prepaid card or payroll card you already have -- but if you get a new one, make sure you check costs carefully and watch out for hidden fees and penalties. "Be careful -- some cards are better than others," Wu says.
- Get your taxes prepared for free. If you used refund anticipation loans -- or their nonloan relative, refund anticipation checks , which can still carry hefty fees -- to avoid paying for tax preparation upfront, consider a free alternative. The IRS offers several options: Free File -- with free online software with fillable forms, available to anyone, as well as volunteer-based assistance programs for taxpayers who generally make less than $50,000 and those who are 60 or older.
- Sock away your tax refund. "Put some of your refund into emergency savings so, for the rest of the year if you have an unexpected expense or shortfall, you can borrow from yourself rather than paying triple-digit interest to borrow from a payday lender, car title lender or other bad option," Fox says.
Consumer groups say that as banks stop making refund anticipation loans, payday and other non-bank lenders likely will try to pick up more of that business. And, cash-strapped consumers will still seek out RALS, according to Feddis. "If they need it, they will try to find someone willing to make the loan," Feddis says.
However, King says, improving technology at the IRS -- which could soon mean even speedier refunds that could take only a few days -- and other innovations such as Free File mean consumers should not be too upset over the demise of refund anticipation loans as we know them. King says: "RALs, if they were ever needed, are just about obsolete now."
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