The Risks and Benefits of Tax Advance Refund Loans

a close up of a tax form
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Hate to wait for your tax refund? There are ways to get that refund before the IRS processes your return and sends your money. However, you need to be sure that you’re not using an expensive “loan,” and there are typically limits on how much you can receive.

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 prevent tax preparers from offering refund anticipation loans, noting that they primarily took advantage of low-income taxpayers who were least able to afford them.

Today’s Refund Advances

Since disappearing, refund advances have made a comeback. Major tax preparation companies advertise the service in storefronts and on street corners. The goal of those programs is, not surprisingly, to bring in new customers.

Free Money?

At some of those tax services, refund advances are truly free: You get a loan, 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 have evolved to become a customer-acquisition tool. Tax services let you borrow money at no cost, and the interest they pay (and the risk they take) is a cost of doing business.

You Still Pay

However, 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 still find ways to earn extra revenue on top of your preparation fees.

  • If you don’t pay for your tax preparation up front (having the fee deducted from your return instead), tax services typically charge an additional fee. Those who need refunds often 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’d get approved 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 done.

The Costs

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, are generally quite high (several hundred percent). In essence, you're paying fees to get your own money more quickly than you'd otherwise get it.

Tax preparers generally charge a flat fee to process your refund anticipation loan. Those fees might be around $30 for a Federal refund, plus additional fees for state refunds. Plus, you might have to pay extra, 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).

The Risks

Aside from the high cost, 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. What's more, 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 Loans and Advances

  • Use direct deposit: In most cases, you’re better off just waiting for your refund. The IRS estimates that you'll get your refund in roughly ten 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’re saving money each month. Some people use tax refunds to pay off holiday debt, but it’s better to save in advance and pay cash for gifts.
  • Borrow elsewhere: If you absolutely must borrow immediately, look for less expensive alternatives. A tax preparer does your taxes — that’s not the best place to get a loan. You pay a price for convenience when you use a tax refund loan, but other lenders will gladly compete for your business and give you a better deal.
  • Borrow from online lenders, including peer to peer lenders.
  • Apply for unsecured loans at your bank or credit union.