Jan. 5, 2007
Law Professor Finds Pitfalls In Tax Refund Anticipation Loans
Tax season has arrived again and many tax filers will soon have the opportunity to secure a refund anticipation loan that puts money in their pockets as soon as they sign their 1040.
But a University of Iowa law professor said taxpayers should fight the temptation because for most consumers, the costs of a refund anticipation loan (RAL) outweigh the benefits, especially for those eligible to receive the Earned Income Tax Credit.
"Refund anticipation loans aren't a good deal," said Katherine Porter, an expert in bankruptcy and consumer law who studies the links between bankruptcy and credit. "With an RAL, you forfeit a significant fraction of your refund to the lender; you are paying for the privilege to borrow from yourself."
RALs are a service offered by many commercial tax preparation companies in which the company advances a taxpayer their refund with a short-term loan, after subtracting a fee. But Porter said that many times the fees are so high they wind up eating a significant amount of the refund and give the loan a triple-digit annualized interest rate of 100 percent or higher.
Porter said the loan programs also hurt all taxpayers because RALs are used especially heavily by low-income taxpayers who receive the Earned Income Tax Credit.
"Only about 1 percent of all taxpayers take out refund anticipation loans, but studies show that among recipients of the Earned Income Credit, the use is many times higher," said Porter. The idea behind the credit is that the tax break will provide money the taxpayer can use to build wealth, such as starting a savings account, a college fund or an IRA. Using that money instead to pay for a refund anticipation loan goes against the intent of the credit, Porter said.
"A person's ability to use the Earned Income Credit to help them build their personal wealth is considerably diminished when they're leaving a big part of it with their tax preparer," said Porter.
A new twist on refund anticipation loans was introduced recently when commercial tax preparers began offering what they call pay-stub loans. This service lets taxpayers get a short-term loan using their end-of-year paycheck stub to estimate their tax refund. The loan is paid off when the taxpayer receives his or her refund after their taxes have been prepared. Porter warns that these pay-stub RALs loans aren't just a bad deal, they carry a significant amount of risk for taxpayers because if the loan exceeds the refund, taxpayers will have to make up the difference out of their own pockets.
"RALs carry big risks for the consumer that the consumer may not know about," said Porter. "All of these high-cost types of loans raise the same questions about whether the consumers are getting enough information to make an informed decision. Do they really understand the product? Are disclosures as full and accurate as they need to be? Did they compare fees to find the best deal?"
On top of that, she said the loans are becoming increasingly unnecessary because the IRS now allows electronic filing over the Internet at a much lower cost than the corporate tax preparers charge for RALs (it's free for taxpayers eligible for the Earned Income Credit). Those who file electronically usually have their refunds deposited to their bank account in a matter of days or weeks.
"The tools are there to file more quickly and get a refund more quickly as the IRS improves its technology and efficiency," Porter said.
Porter teaches bankruptcy, commercial law, and consumer law with particular areas of interest in rural financial hardship, mortgage consumer protection laws, and predatory or high-yield lending. Porter conducts empirical research on consumer and commercial laws, with her current research examining mortgage claims in consumer bankruptcies, funded by the National Conference of Bankruptcy Judges' Endowment for Education. She is also a principal investigator in the Consumer Bankruptcy Project. She is a graduate of Yale University and earned her law degree from Harvard University.
STORY SOURCE: University of Iowa News Service, 300 Plaza Centre One, Suite 371, Iowa City, Iowa 52242-2500.
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