Tax refund loans aren't worth interest as high as 1,700%

PERSONAL FINANCE

February 06, 2005|By EILEEN AMBROSE

UNDERSTANDABLY, if you're due a tax refund, you'll want it sooner than later.

But how much is it worth to you to get your refund, say, a week or two earlier than usual?

Would you be willing to take out a small bank loan with an effective annual interest rate of more than 700 percent? Or more than 1,700 percent?

If previous tax years are any indication, about 1 in 10 taxpayers this year will do just that. Most of them, too, will be low- to moderate-income workers who are the least able to afford these loans.

Refund anticipation loans at this time of year are heavily promoted by tax preparers that partner with a bank to offer the loans. Filers essentially borrow the amount of their expected refund minus fees, and the loans are repaid within two weeks when the Internal Revenue Service deposits the actual refund with the bank.

The charges might not seem much to get a refund in one to three days. But paying the typical bank fees of $30 to $115, depending on the size of the loan, can mean you are paying an effective annual interest rate of 40 percent to more than 700 percent, according to a recently released survey by the National Consumer Law Center and the Consumer Federation of America.

Add on a $28 to $59 administrative fee sometimes charged by the tax preparer, and the annual interest rate can range from 70 percent to more than 1,700 percent, the groups said.

Consumer advocates have railed against the loans for years, arguing they are too expensive and unnecessary for those with a little patience. By filing electronically through an IRS program, for example, taxpayers can get their full refund deposited in their bank account in two weeks or less for free.

Last week, Maryland's attorney general also issued a warning about the pricey loans. "Why pay some company to get your refund for a few days sooner, when there are alternatives that won't cost you anything?" said Attorney General J. Joseph Curran Jr.

Consumer groups' efforts to call attention to the cost of these loans appear to be having an impact.

A handful of states and cities in recent years have adopted legislation to protect consumers, in some cases requiring greater disclosure on the loans, said Jordan Ash, director of the ACORN Financial Justice Center in St. Paul, Minn.

Federal legislation is expected to be reintroduced this week to curb the use of the loans. One provision would prohibit a refund anticipation loan from being used for refunds received under the earned-income tax credit, a tax break that helps lift the working poor out of poverty.

And major tax preparers are also making changes to their loan products.

H&R Block, the largest tax preparation chain, said last month that it would no longer charge an administrative fee of about $32 for refund loans, accelerating its plan to phase-out the charge over three years. Bank fees still would apply.

"It's a great step. We want all the other tax preparers to follow their lead," Ash said.

Block spokeswoman Denise Sposato said that every year the preparer improves its product disclosures, and last year began working with ACORN (Association of Community Organizations for Reform Now) to get its input.

Last month, Jackson Hewitt Tax Service Inc., the second-largest tax chain, said it was increasing disclosure on refund products.

About 12.1 million filers took out a refund anticipation loan in 2003, according to the consumer groups' survey. That's down from 12.7 million the year before, but still a high number.

And there remains a lot of confusion about the loans. For instance, 70 percent of borrowers didn't understand they were taking out a loan, the survey found.

"We are amazed how many people who use [refund anticipation loans] still don't realize what they have is a loan," said Jean Ann Fox, director of consumer protection for the Consumer Federation of America. "Anytime you will get cash within one to three days of filing, it's not an IRS refund. It's a bank loan that has to be repaid."

If for some reason borrowers' refunds are smaller than anticipated, they will end up owing money to the bank. And if they already spent the loan, they might not have the cash.

Filers most likely to take out the loan are those who would be hard-pressed to come up with extra cash. Seventy-nine percent of refund anticipation loan borrowers had incomes of $35,000 or less, the survey said.

And about 57 percent of borrowers, or 6.92 million filers, received the earned income tax credit. These households paid $1.57 billion in tax preparation and loan-related fees, the consumer groups said.

So, what alternatives do filers have?

They can file their returns electronically through the Free File program offered by the IRS at www.irs.gov. The agency has teamed up with 19 tax preparation companies to offer online filing for free.

Also, free tax help for low- and moderate-income taxpayers is available through Volunteer Income Tax Assistance sites. To find the nearest site call the IRS at 800-829-1040.

Having the IRS directly deposit a refund in your bank account speeds up the process. Those who don't have a bank account will have to wait for a check to be mailed.

But direct deposit is a good excuse to open a bank account, which you can use year round. Some banks might charge a fee to set one up, but it likely will be less than loan charges, Fox said. And you won't have to pay a check-cashing fee, either.

To suggest a topic, contact Eileen Ambrose at 410-332-6984 or by e-mail at eileen.ambrose@baltsun.com.

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