Bankruptcy

Anticipating Refund Anticipation Loans

By Katie Porter

I've clearly become predictable in my posts, as someone recently wrote to me wondering where is my annual tax-time rant against refund anticipation loans (RALs). In fact, I have written about them twice before on Credit Slips, here and here. But I think this annual lending "opportunity" deserves another round of criticism; this is a bad product that just won't seem to die. The number of RALs held fairly steady between 2006 and 2007, around 9 million loans.

RALS are 1 to 2 week loans administered by tax preparers and banks working together. The loans are secured by the taxpayer's expected refund.  In their new report on RALS, the National Consumer Law Center and the Consumer Federation of America find that a typical RAL is about $3,000 and carries an APR of 77% to 140%. While the high APR for a RAL makes it similar to other short-term loans such as payday loans, there are some unique justifications for regulating or discouraging RALs that go beyond the high price paid by consumers.

First, about 2/3rds (63%) of RAL borrowers receive the Earned Income Tax Credit. Such taxpayers are only 17% of the entire population. The beneficial purpose of the Earned Income Tax Credit, which is funded by all of our tax dollars, is diluted when borrowers pay a chunk of their credit to banks and tax preparers for an RAL. Second, consumers taking out RALs appear to misunderstand their ability to access their tax refund quickly. A survey by the Treasury Inspector General for the IRS found that 85% of RAL taxpayers were willing to wait up to 9 days to receive their refund. Yet, if taxpayers e-file and use direct deposit, the average IRS processing time is 10 days. Third, RALs appear to increase tax noncompliance, probably because they incentivize preparers to inflate refunds. The IRS has determined that RAL users are 27-36% more likely to be noncompliant than non-RAL taxpayers.

States have tried to regulate RALs but faced preemption battles. In 2008, the Second Circuit invalidated a Connecticut statute that prohibited tax preparers from facilitating RALs with APRs that exceeded 60%. Federal legislation seems to be the only option for limiting RAL fees. If Senator's Durbins bill proposing a 36 percent cap on consumer lending becomes law, I may have to find a new way to mark the arrival of spring than a post on RALs!

Full post as published by Credit Slips on March 07, 2009 (boomark / email).