Christmas Loans

The Holiday Borrowing Risk List

Ch. 3.3. Refund Anticipation Loans

When thinking about holiday spending, some people look beyond the holidays – all the way to tax season. A refund anticipation loan (RAL) is a loan in the amount of what you think your tax refund is going to be come April. Typically, it’s a shorter-term loan of a few weeks, but in recent years more and more lenders have been offering them around the holidays, especially in states that don’t allow payday lending.

These type of loans are not very consumer friendly and often come with triple-digit interest rates and high processing fees. Additionally, while you may think you know what your tax return may be, it’s often hard to exactly predict. If you take out a RAL and end up getting less than you anticipated in your tax refund, you still owe the amount you took out.14

Even the federal government has qualms about these kinds of loans. Kelly Erb, a senior editor at Forbes who writes as the Tax Girl, said that in 2011, the Internal Revenue Service became very concerned about RALs, considering them predatory loans.

Since the average person filing their taxes doesn’t know all the intricacies that go into measuring how much they’ll get back, big tax preparation companies were free to give out large loans with high fees and tack on extra deductions that the borrower might not actually qualify for. After the IRS announced it would no longer be providing tax preparers with “debt indicators,” which are one-letter codes that let lenders know whether taxpayers owe back taxes or have other federally-owed financial obligations for the 2011 tax season, tax preparers scaled back on RALs, but they do still exist.

Changes have also been made to how quickly people can get their refunds back based on what types of deductions they make. For example, the Earned Income Tax Credit (EITC) is mainly for low- and middle-income earners, and in order to qualify for it, the IRS requires you to be within certain income limits.15  Erb said the EITC has been ripe for fraud, so the IRS delays distributing refunds that utilize this credit until everything can be verified. Delays in receiving your tax refund are another reason why taking out an RAL is a bad idea: if you’re not getting your refund on time, you won’t be able to pay back your loan on time, which can mean a tanked credit score and even more fees to pay.

When it comes to getting the most out of your taxes, Erb’s pro tip is to use a tax preparer to maximize your refund. This may seem like a waste of money, but tax experts are able to learn the ins and outs of your specific situation and get you more money back on your return, which can jumpstart your financial health early in the year. The better your finances, the less likely you are to need to take out a loan around the holiday!

Advice from Kelly Erb (@taxgirl): 

“There are smarter options available for financing your holiday expenses. Instead of taking out a high-interest refund anticipation loan with lots of fees attached, adjust your withholding rate that controls the amount of tax taken out per paycheck. If your income stays generally the same and you get the same amount in your refund year after year, change your number of allowances so that you get more money back per paycheck throughout the year.

If you’re not adjusting your withholding, you’re essentially using the federal government as a savings account, but you’re not accruing any interest to grow your savings. If you get more per paycheck and put that into a savings account with a good interest rate, you can afford to make big purchases around the holidays without taking out a new line of credit or increasing your credit card limits.

You can still take trips, but it might be best to wait until after the holidays. If you’re wanting to take your kids on a big trip, say to Disneyland, you can give your kids a Mickey Mouse stuffed animal during the holidays and tell them that you’re taking a trip in a few months. That gives you more time to save or pay for the trip, but still keeps the holidays exciting.

One thing people do that is actually a really big don’t: withdrawing money from your retirement fund to finance the holidays. Some people do this and believe they can replace the money later on, but no matter what you’re going to get charged a large penalty for drawing on those funds.”

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