How Tax Refund Advances and Loans Work: Pros and Cons
Hate waiting for your tax refund? You can potentially get your refund before the IRS processes your return and sends your money. But you might be getting yourself into an expensive “loan,” and you may end up paying for services you don’t really need. If you file your taxes electronically and use direct deposit for your refund, you should get your money within 21 days or so.
In the past, refund anticipation loans were expensive — similar to payday loans. Those loans may still be out there, although the major tax preparation services have moved away from them. Around 2012, regulators took action to reduce tax preparers from offering refund anticipation loans, noting that they primarily took advantage of low-income taxpayers who were least able to afford them.
Refund advances are still a thing, and they’ve made a comeback. Major tax preparation companies advertise advances in storefronts and on street corners. The goal of those programs is, not surprisingly, to bring in new customers.
With some tax preparers, refund advances are available at no additional charge: You get an advance on your refund, and you don’t pay interest or fees on the money you borrow. If it turns out that the IRS refunds less than you received, the tax service might not be able to come after you for the difference (consult with a local attorney before you assume you’re in the clear).
Instead of using refund loans as a profit center, refund advances can work as a marketing tool. Tax services let you borrow money at no cost, and any interest they pay (and the risk they take) is a cost of doing business.
You Still Pay
There’s no free lunch. You’re still paying fees to get your taxes prepared, and the cost of refund advances is baked into the tax preparation fees that everybody pays. In addition, tax services may find other ways to earn extra revenue on top of your preparation fees (by selling additional services, for example).
- If you don’t pay for your tax preparation up front (having the fee deducted from your return instead), tax services may charge an additional fee. Those who need refunds typically don’t have the cash to pay for preparation up front, so this is a meaningful source of revenue.
- If you use a payment card provided by the tax service, the card may charge additional fees. Prepaid debit cards can have monthly fees and other charges. Credit cards can charge high interest rates and annual fees.
Traditional Refund Anticipation Loans
Traditional tax refund loans are less consumer-friendly than today’s refund advances. However, you may still see offers for those types of loans, so it’s important to understand how they work. Those loans are typically financed by small finance companies — not major banks working with household-name tax preparation services.
With the older version of loans, you qualify based on the expectation of a loan coming from the IRS. Your tax preparer might provide a prepaid card with funds loaded onto it, a paper check, or an electronic deposit to your bank account.
Once the IRS processes your return, the refund goes directly to your lender. The loan gets paid off, and you’re finished with the lender, although you may still have funds for spending.
Traditional refund anticipation loans are expensive. You're really only borrowing for a few weeks, but you have to pay fees and interest on the loan. Those costs, when converted to an annual percentage rate, can be quite high (several hundred percent APR, for example). In essence, you're paying fees to get your own money more quickly than you'd otherwise get it.
Tax preparers may also charge a flat fee to process your refund anticipation loan. Those charges might be $30 to $50 for a Federal refund, plus additional fees for state refunds. Plus, you might have to pay additional charges, depending on how you get the funds (an additional $30 fee for a printing a check or providing a debit card is not unheard of).
Aside from paying potentially high costs, you never know for sure how much you'll get from the IRS. If your tax preparer miscalculates or the IRS disallows any of your deductions, you might end up with less money than you borrowed. But you still have to pay off the loan. For example, the IRS might withhold funds for things like unpaid child support or tax liens.
The lender knows that your loan will be repaid because they prepared your tax return — they know how much to expect from your refund. Therefore it's a low-risk loan for your lender — but you pay as if you were a high-risk borrower. When you add up the fees relative to the amount most people borrow, these loans can end up costing roughly as much as payday loans (which are notoriously expensive).
Alternatives to Refund Loans and Advances
- Use direct deposit: In most cases, you’re better off just waiting for your refund. The IRS estimates that 90% of refunds arrive within 21 days if you e-file and use direct deposit. Paying $40 or more for ten days is a lot of money. Learn how to provide direct deposit instructions.
- Minimize your refund: If you rely on annual refunds, you’re making your life difficult, giving the IRS an interest-free loan, and paying hefty fees while you’re at it. Adjust your withholding so that your employer takes the correct amount from your pay, and develop a budget so that you save money each month. Some people use tax refunds to pay off holiday debt each year, but it’s better to save in advance and pay cash for gifts.
- Borrow elsewhere: If you absolutely must borrow for immediate needs, look for less expensive alternatives. A tax preparer does your taxes — they’re not professional lenders. You pay a price for convenience when you use a tax refund loan, but other lenders will compete for your business and potentially give you a better deal.
Consumer Financial Protection Bureau. "Making the Most of Your Tax Refund," Accessed Nov. 11, 2019.
Minnesota Attorney General. "Tax Preparer Fees and 'Tax Time' Financial Products," Accessed Nov. 8, 2019.
Consumer Financial Protection Bureau. "Tax Refund Tips: Understanding Refund Advance Loans and Checks," Accessed Nov. 8, 2019.
Internal Revenue Service. "What to Expect for Refunds in 2019," Accessed Nov. 8, 2019.