Why Tax Refund Advance Loans Are Bad

A 1040 tax form with a green "refund" stamped on top of it, indicating that a tax refund is being issued.

For some people, a tax refund can be a nice addition to the 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 extra money for your savings account.  

Once you've had your taxes prepared and you file your tax return, a tax refund can take weeks to be processed for you to get your actual tax refund. 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 advance loans to get an advance on their tax refund. While taking a refund advance loan may get you access to your money sooner, it’s important to read the fine print on early refund advance loans.

What is a Tax Refund Advance Loan?

A tax refund advance loan (RAL) is a short-term tax refund loan that a third-party lender based on a taxpayer's expected refund for that year issues. The refund advance program lender will give you a refund advance loan for the money that you’re expected to receive from your tax refunds based on tax documents prepared by your tax professional. The refund advance loan comes without any applicable tax refund loan cost like interest charges or loan fees. Once the IRS prepares your official tax refund, the money goes straight to the lender's checking account to repay the early refund advance loan that was provided to you.  

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

Refund Advance Loan vs. Refund Anticipation Check

Today, a tax refund advance loan has a slightly different name. Following a regulatory crackdown before the 2013 tax season, refund anticipation checks (RACs) have mostly replaced RALs. However, they’re still available from a third-party lender.

Refund anticipation checks are similar to RALs and are often seen as interchangeable. Unlike refund advance loans offered by private third-party lender companies, companies that offer tax preparation services generally offer these checks. These checks are less risky than RALs, do not accrue interest charges, and are offered as part of their package for their tax preparation services.  

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 tax refund dollars the most.  

How Refund Anticipation Checks Are Processed

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

When the IRS issues your official expected refund, it is deposited into a temporary checking 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 preparation services.

Who Offers Tax Refund Advance Loan Online?

Online lenders 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 the 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:

Tax Refund 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 tax 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 tax refund directly from the IRS sooner:

  • Make sure you have a bank account that supports direct deposit into a checking account. Electronic deposit options can drastically reduce the amount of time it takes for the IRS to process your tax return and release your tax refund, which could be just a few weeks. Also, 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 ask for an electronic direct deposit into a checking account. With paper returns, it can take 12 weeks before the IRS processes your tax return and sends you a check. With electronic filing, the IRS estimates a 21-day turnaround to process a direct deposit into your checking account.

Can You Get a Refund Advance Loan with Bad Credit?

If you have bad credit but need the money, you may be able to get a refund advance loan. There are some companies that claim to give a tax refund loan without a credit check, though others will require credit history checks. Some will acknowledge your bad credit but may charge higher fees for a tax refund loan because of not meeting the eligibility criteria for their credit score requirements.

If you’re planning on getting an early refund advance loan, your best bet is to simply call the tax preparer you plan on going to and ask about the tax preparation details beforehand. Ask the tax preparer about tax preparation fees, loan fees, additional fees, eligibility requirements for a loan, or other tax documents that are needed from eligible taxpayers.

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 Advance 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 by 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 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 over-borrowing, you may end up paying a significant part 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 act 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 called 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.  

Need Help Improving Your Credit?

Landing in a cycle of debt can hurt your finances and limit your access to additional personal loans or lines of credit. If you need assistance in tackling debt and building up your credit score, talk to one of our credit counselors for free today.

Article written by
Melinda Opperman
Melinda Opperman is an exceptional educator who lives and breathes the creation and implementation of innovative ways to motivate and educate community members and students about financial literacy. Melinda joined credit.org in 2003 and has over two decades of experience in the industry.

Take the First Step Towards Financial Freedom!

Subscribe to our newsletter
Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.