Why Tax Refund Anticipation Loans Are Bad For Credit

For some people, tax refunds can be a nice addition to a bank account each year. However, if you have a list of urgent bills, overdue debts, or large purchases, your tax refund might be more of a financial necessity than padding for your savings account. 

Once you file your taxes, refunds can take weeks to be processed and dispersed. So, if you need it as soon as possible, it can be tempting to find a way to get your money faster. 

Some people look for tax refund anticipation loans to get an advance on their refund. While taking one out may get you access to your money sooner, it’s important to read the fine print.

What is a Tax Refund Anticipation Loan?

A refund anticipation loan (RAL) is a short-term loan that’s issued by a third-party lender based on a taxpayer’s expected refund for that year. The lender will give you an advance for the money that you’re expected to receive from your tax refund without any applicable interest and fees. Once the IRS prepares your official refund, the money goes straight to the lender to repay the loan. 

It sounds too good to be true. Beware: if your official tax refund is less than what you borrowed, you may be on the hook for the difference. Fees will add up on processing your refund as well as your refund anticipation loan, resulting in many hidden costs. If you were already in dire need of the additional funds, before you know it you may be in need of more or begin deferring other payments

Refund Anticipation Loans vs. Refund Anticipation Checks

Today, tax refund anticipation loans have a slightly different name. Following a regulatory crackdown prior to the 2013 tax season, RALs have been mostly replaced by refund anticipation checks (RACs). However, they’re still available from private lenders.

Refund anticipation checks are similar to RALs and are often seen as interchangeable. Unlike the loans offered by private lending companies, these checks are generally offered by companies that offer tax preparation services. These checks are less risky than RALs, do not accrue interest, and are offered as part of their package for the service of preparing your taxes. 

RALs and RACs are most appealing to people who want or need their tax refund money as soon as possible. As you may expect, they’ve earned a reputation for inflated fees and rates that take advantage of the people who need their refund dollars the most. 

How Refund Anticipation Checks are Processed

Once your tax preparer determines your refund, they will issue you a check for the amount you will receive, minus the fee they charge to prepare your taxes from the loan amount. 

When the IRS issues your official refund, it is deposited into a temporary account that is used to pay the tax preparer. Although you are not subjected to high interest rates, you may still see fees for tax services.

Who Offers Tax Refund Anticipation Loans Online?

Companies providing RALs are typically eager to offer them to any qualifying customer. Low-income and moderate-income taxpayers may have a harder time saying no, even if they want to avoid interest and fees if they see a loan as their best option to access tax refund funds they need right away. Before you resort to a loan that disadvantages you, try these options to get your tax refund as soon as possible, without involving lenders:

Refund Anticipation Loan Alternatives

It may be worth looking into other tax refund options before you make a decision. If you need to make ends meet, here are a few ways to get your refund quickly without involving lenders:

  • Get assistance from trained volunteers in Volunteer Income Tax Assistance (VITA) and Tax Counseling for the Elderly (TCE) programs. These programs help low-to-moderate-income and senior taxpayers complete their tax returns for free. Visit the IRS VITA Locator tool or call 800-906-9887 to learn more and find a local VITA center near you.
  • Go to your local public library or community center. Staff may be able to provide contact information for local VITA and TCE centers or have computers you can use for free.
  • Make sure you’re not withholding too much. If your tax refund is considerably large, you may be withholding too much money from your paychecks. If this is the case, you’re essentially giving the IRS an interest-free loan. You’re better off seeing that large refund as a smaller bump in each of your checks.

Related Articles: 6 Alternatives to Debt Consolidation & Debt Counseling

How to Get a Fast Tax Return

Additionally, there are steps you can take to get your refund directly from the IRS sooner:

  • Make sure you have a bank account that supports direct deposit. Electronic deposit options can drastically reduce the amount of time it takes for the IRS to process your file and release your refund, which could be just a few weeks. In addition, check cashing services charge fees. Many banks and credit unions have free account options, and they’ll set you up at no charge.
  • Submit your taxes via e-file and request a direct electronic deposit. With paper returns, it can take 12 weeks before the IRS processes your file and sends you a check. With electronic filing, the IRS estimates a 21-day turnaround to send refunds.

Can You Get a Refund Anticipation Loan with Bad Credit?

If you have bad credit but need the money, you may be able to get a refund anticipation loan. There are some companies that claim to give anticipation loans without a credit check, though others will require credit checks. Some will acknowledge your bad credit but may charge higher fees as a result.

If you’re planning on getting an anticipation loan, your best bet is to simply call the tax preparer you plan on going to and ask about the details beforehand.
Learn More: What is a Good Credit Score?
Related Articles: How to Buy a House with Bad Credit

What are the Hidden Costs of Refund Anticipation Loans and Checks?

Some hidden costs of RALs and RACs include: 

  • E-filing fees
  • Check cashing fees
  • Other ‘junk fees’
  • High interest rates

You won’t know the exact amount of your refund until the IRS has finalized their review of your tax forms. Although your tax forms may give you a general idea, federal and state agencies can still garnish your tax refund if you have outstanding debts, such as unpaid mandated child support or Stafford student loan payments.

Tax anticipation loans are based on your anticipated refund, not the actual amount issued from the IRS. You must pay back the entire amount you borrowed, even if your actual refund is lower than you expected.
Learn More: What Are Interest Rates & How Does Interest Work?

How Do Refund Anticipation Loans Affect My Credit Score?

Whenever you receive a loan, your credit may be impacted. For tax refund anticipation loans, this depends on how the loan provider qualifies you during the application process. If there is a hard inquiry made into your credit report then your credit score may be negatively impacted. If all they do is a review, or make a soft-inquiry into your credit report, then your credit will not be impacted.

If you’re unable to repay the loan, your debt is likely to come with the high interest rates. Entering a refinance or rollover plan with your lender could put you in a cycle of debt, leaving you to pay much more than your refund was ever worth. This debt can ultimately harm your credit score. 
Related Articles: How Does a Debt Management Plan Affect Your Credit?

The Problem with Interest-Free Loans

Although refund checks do not charge interest or run the risk of overborrowing, you may end up paying a significant portion of your tax refund in unexpected fees. These fees are based on the difficulty of the return and can range from zero to hundreds of dollars. 

Some services include fees to defer payment on preparation services which acts similarly as interest would for the refund check. Additionally, many fees can be tacked on for vague costs such as data and document storage or a “technology fee.” These are often referred to as junk fees. 

Discovering the true cost of the services is difficult to determine beforehand. If you do decide to seek help from a service that uses refund anticipation checks, it’s important to remember that the cost they quote you in the beginning may be much higher by the end of the process. 

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About The Author

Jessica Sillers writes about finance, small business, and parenting for various publications and websites. She loves helping people feel more confident about balancing money and life goals. When she's not writing, you can find her with her nose in a book, or at www.dcfreelancewriter.com.