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A '(Tax) Refund Anticipation Loan' ('RAL') is a high interest rate short-term loan secured by a taxpayer’s expected tax refund.

Contents

United States

Controversy

Canada

References

External links

United States

In the United States, the taxpayer commonly applies for the loan through a paid tax preparation firm. The tax preparation firm receives a fee for each loan originated, but in the United States the Internal Revenue Service rules prohibit basing this fee on the amount of the expected refund. Only the banks through which the loan is made are allowed to charge interest or finance charges.
According to the National Consumer Law Center, 12 million taxpayers used an RAL in 2004.^[1] With e-filing, tax refunds can be direct-deposited into the taxpayer's bank account within two weeks, rendering RALs less attractive to some.

Controversy

Despite their commonplace nature, RALs are controversial. Supporters of the practice say the loans allow people access to funds immediately in cases of an emergency such as overdue medical bills, credit payments, and other debts while they wait for the IRS to process their income tax return. Processing of a tax return can take anywhere from one week to a month and a half. Fees for these loans are in line with industry wide standards for non-secured loans. Supporters of RALs may also contend that many individuals are not entirely truthful when completing their taxes, and that banks take a great risk relying on the word of an individual that his or her tax refund will be received in the amount claimed.
Opponents of RALs such as the National Consumer Law Center argue that the profit motive of the lender results in RALs being issued too often to low-income individuals who are made to think the wait for their refund is longer than it really is, who do not realize they are making a loan, who do not understand the high interest rates charged by the loan (often exceeding 100% APR), and who do not actually need the funds immediately. An empirical study at Georgetown University found that a large fraction of RAL customers appear to use limited decision processes.^[2]
Even cash advances on credit cards have much more attractive rates than RALs. For example, a representative RAL is a ten-day $3,000 refund anticipation loan with a loan fee of $89-$170, resulting in an annualized interest rate between 108% and 202%.
More than half of all RAL consumers are low-income recipients of the Earned Income Tax Credit (EITC), despite the fact that EITC recipients constitute only 15% of all taxpayers.
In 2002, H&R Block settled a lawsuit brought by the New York City Department of Consumer Affairs for predatory lending practices with regard to RALs and the EITC.
In 2003, the Illinois Attorney General issued a detailed warning to taxpayers about such loans.
On February 15, 2006, the California Attorney General, Bill Lockyer, sued H&R Block over its refund anticipation loan business. The interest rates charged in that business exceed 500%, including fees. Lockyer said the company falsely portrays the nature of the loans, advertising "cash, cold, green, in your hand, out the door." In May 2005, a federal judge in Chicago rejected a $360 million settlement as inadequate.^[3]
In December 2006, firms like Jackson Hewitt and H&R Block were making loans for Christmas. Technically, these unsecured loans are not refund anticipation loans but for the actual fact that these lenders require borrowers to show a pay stub on which to base the tax refund.
Because of this pressure HSBC which backs H&R Block and the largest provider of RALs, has announced it will be withdrawing for the industry.

Canada

In Canada the process is referred to as "tax rebate discounting", where a tax preparation firm purchases the right to the anticipated refund in exchange for a percentage of the refund amount. Canada Revenue Agency rules establish the maximum discounting fee as 15% of the first 300 C$ and 5% of any remaining amount. No other fees for preparation or filing the return are permitted. This commonly works out to a high effective interest rate, although in a small number of cases the discount may be comparable or even less than an ordinary tax return preparation fee.

References

1. http://msnbc.msn.com/id/11362964/
2. http://www.business.gwu.edu/research/centers/fsrp/pdf/M37.pdf
3. http://msnbc.msn.com/id/11373754/

External links

★ Consumer Use of Tax Refund Anticipation Loans, Gregory Elliehausen, McDonough School of Business, Georgetown University, April 2005.

★ National Consumer Law Center: Refund Anticipation Loans

★ ''E-filing can make high-fee loans unnecessary'', MSNBC, 2006-02-15

★ ''Calif. sues H&R Block over tax refund loans'', MSNBC, 2006-02-15