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Smart Alternatives to Tax Refund Anticipation Loans

| Money Rates Columnist.
min read

money-mousetrap

If you're desperate for cash, you may be tempted by tax refund anticipation loans (RALs), aka refund anticipation checks. Try to resist! Because these typically lack transparency and can turn out to be very expensive.

Here are some alternatives -- including ways to get your money more quickly from the IRS.

Read to the end and you should be able to keep more of your own money to spend on yourself and your family.

What is a Tax Refund Anticipation Loan (RAL)?

A tax refund anticipation loan is a type of loan offered typically by tax preparation companies. As the name implies, it is supposed to provide you with an advance on the money you're owed in refunds by the tax authority. So you're most likely to be offered one during each year's tax season, between December and April.

Don't be confused by the more recent term, "tax refund checks." These are essentially the same thing. In advance of the 2013 tax season, new regulations cracked down on the original loans. And calling them checks was little more than a rebranding exercise to skirt some of the new rules. So any RAL is a loan and so is a refund anticipation check. Oh, and "refund advance loans" are the same thing too.

Usually, these are very short term loans. The IRS says on its website that it "issues more than 9 out of 10 refunds in less than 21 days." In this article, you'll learn how you can get your money from the government as quickly as possible.

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Why Tax Refund Anticipation Loans Are Better Avoided

Nowadays, you may not be charged interest on your RAL or check. But don't be fooled. Because that doesn't mean it will be free. Fees are all but inevitable.

And costs are often surprisingly high, even if they don't look that way on your loan agreement. Consumers often find they receive only 90% or less of their actual refunds.

So, if the tax authority sends your money in a matter of days (as often happens), that would translate into the sort of annual percentage rate (APR) that should be avoided by those with a fear of heights. We're approaching payday loan territory here.

The expense of tax refund anticipation loans is the main objection to them. But there are others:

  1. Lack of transparency

    RALs not always as transparent as they should be. Costs and conditions may not be obvious and you need to watch out for hidden, additional fees.

  2. Better options are available

    There are better ways to borrow. You can save money by exploring your options.

  3. Little recourse

    You're almost certainly on the hook if your refund is less than you were hoping -- Expect plenty of hassle as your lender demands its money back

These loans are most often used by low- and moderate-income households. And tight cash flow can make them seem irresistible. But resist if you possibly can. You could save a bundle at a time when you need it most.

How to Get Your Refund More Quickly from the IRS

Whatever you do, there's always a possibility of your income tax filing raising red flags and requiring additional review. And that can increase the time it takes the IRS to send you your refund. But these events are relatively rare for honest taxpayers with fairly straightforward finances.

You can significantly reduce the time it takes for you to get your tax refund, however, just by using technology. Did you know that eight in 10 taxpayers already "get their refunds faster by using e-file and direct deposit," in the words of the IRS?

If you aren't already streamlining the process in this way, you're delaying getting your hands on your money. So read on for some options.

Electronic filing (e-file)

Here are your e-file options:

  • If your adjusted gross income is $69,000 or less, you can use the IRS Free File online service at no cost
  • An alternative for those confident with do-it-yourself tax returns is Free File Fillable Forms, also online through the IRS website
  • The IRS Volunteer Income Tax Assistance (VITA) and the Tax Counseling for the Elderly (TCE) programs give no-cost tax help and e-file services to those who are eligible
  • If your affairs are too complicated for those free options, you can use commercial tax-prep software to file electronically
  • Use an authorized e-file provider

Choosing one of those options would normally slash the time between your filing your tax return and your receiving your refund. And that means you may not have to borrow from anyone to cover such a short period.

Direct deposit

You can shave even more time off your wait by opting for a direct deposit. In other words, the IRS sends the money directly to your bank or prepaid debit card account instead of sending you a check through the mail. You don't need a special bank account or to practice online banking. The money just appears.

There are a few rules.

The IRS says: "Your refund should only be deposited directly into accounts that are in your own name; your spouse's name or both if it's a joint account. No more than three electronic refunds can be deposited into a single financial account or pre-paid debit card."

Only those in the direst straits are likely to need to borrow to cover the days or two or three weeks it takes to get a refund the electronic way. For most, tax refund anticipation loans become totally unnecessary.

How to Avoid Paying Too Much Tax in the First Place

Some see tax refunds as one of those increasingly rare bright spots in the year. And they view withholding too much tax as a method of enforced saving that lets them buy some treats, zero their credit card balances or do some home improvements. There's absolutely nothing wrong with that, though you could achieve the same thing with a savings account and earn a bit of interest at the same time.

But those who are tempted by tax refund anticipation loans are unlikely to need the money for treats or anything similar. Presumably, they're mostly desperate to fill gaping holes in their cash flow.

Paycheck checkup

For anyone in that situation, the smarter move may be to withhold less tax in the first place. This lets you use the maximum amount of your earnings throughout the year. That way, you might not have to become desperate about getting a refund from the Internal Revenue Service.

A page on the IRS website provides a Paycheck Checkup tool that "can help you see if you're withholding the right amount of tax from your paycheck." Of course, you don't want to withhold too little or you could face an unexpected tax bill. But, if you're chronically short of money that you really need, withholding too much can be as damaging. You need the Goldilocks amount.

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Better Loans if You Absolutely Need to Borrow

Of course, nobody should borrow anything without a great deal of thought. But, in 21st-century America, very few can get by with zero borrowings. The trick is to find the cheapest form open to you and to make sure you can comfortably afford the payments on the loan offered.

So here are some ways in which you might be able to borrow that could be way less costly than tax refund anticipation loans:

  1. Short term authorized overdraft

    Call your bank and explain that you're waiting for your refund. If you've been a responsible customer, it may well approve your request.

  2. Personal loan with no prepayment penalty

    Find a low rate from your bank or an online lender. Providing there's no prepayment penalty, you can pay down the entire loan early.

  3. Specialist bank product

    For example, U.S. Bank's Simple Loan charges you a $12 fee (providing you use autopay) for each $100 you borrow and you repay over three months. That works out at a high APR, but way less than most payday lenders' would charge.

  4. Friends or family

    For most, this is the last resort. But, providing you know you can repay the debt out of your income tax refund, you shouldn't be putting a valued relationship at risk.

Aside from that last one, you'll likely need at least a fair credit score to get approved for any type of mainstream cash borrowing. The main exceptions are payday lenders, which often make no credit checks. But any company that lends "blind" in that way is bound to charge very high APRs to cover its inevitable losses.

If you are stuck between payday lenders and tax refund anticipation loans, do what you should always do when borrowing: compare quotes to identify the one that will cost you less or least in the end. And make sure you can afford the payments to which you're committing yourself.

But all those apply only to taxpayers who are so desperate that they can't get through the days or two or three weeks before they typically get their income tax refunds. For everyone else, the message is, "Be Patient!" It'll cost you if you aren't.

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