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RALs - Will They Become Extinct?

posted by Nathalie Martin

Refund appreciation loans, or RALs, are among the priciest loan transactions out there.  Customers pay a fee (frequently 40% to 700% if expressed as an APR) to get their tax refund early.  The fees can be much higher.  I saw one where a consumer was owed a $4,000 tax refund, and paid $1,000 of that to a RAL provider, in order to receive the remaining $3,000 two weeks earlier than the customer otherwise would have.  In some parts of the country, for example in Indian Country, RALs seem like the only option.  This year I also saw a very well known tax preparers advertise FREE tax return preparation, only to find out they were actually providing high-fee RALs.  Not so free…..

But the RAL gravy train may be almost over.  The FDIC just ordered one of the last underwriters of the products to stop backing the controversial loans. The FDIC told Kentucky-based Republic Bank & Trust Co. that the loans are unsafe and unsound now that the IRS no longer offers banks its debt indicator, a tool loan providers used to determine whether a taxpayer had outstanding tax liabilities that could be garnished from a tax refund.

Republic, which finances RALs for Jackson Hewitt and Liberty Tax Service, has 60 days to contest the FDIC's assertion -- and it plans to do so, Republic President and CEO Steve Trager told Tax Analysts. Within 60 days, bank officials will have to defend the loans at a hearing before an FDIC-appointed administrative law judge, who will make a recommendation to the FDIC board of directors for a final ruling. The board of directors then has 90 days to make a decision.

Consumer advocates, including Adam Rust of the Community Reinvestment Association of North Carolina, have long criticized RALs for taking advantage of society’s weakest. In 2008, the median annual income of an RAL customer was $19,768. In 2009, RALs took more than $600 million in interest and fees from the refunds of 7.2 million taxpayers, according to the National Consumer Law Center.

John Hewitt, CEO of Liberty Tax Service, defended RAL fees, saying the one-time fees help deliver money quickly to people living paycheck to paycheck. If RALs weren't available, people would pursue other services with potentially higher interest rates. 

Critics of RALs argue that now that the IRS offers direct deposit of tax refunds often within 7 to 15 days, there should be less need for consumers to seek instant refunds. Treasury's new program offering tax refunds directly deposited onto prepaid debit cards should also decrease incentives for taxpayers to seek RALs, said Chi Chi Wu, staff attorney at the National Consumer Law Center. "The IRS is working on getting those refunds even faster. So really taxpa


"In some parts of the country, for example in Indian Country, RALs seem like the only option."

Only option for _what_?! Nobody else is willing to rip people off in "Indian Country"? Sadly, that's not consistent with what I read.

Along similar lines:
John Hewitt, CEO of Liberty Tax Service, defended RAL fees, saying the one-time fees help deliver money quickly to people living paycheck to paycheck. If RALs weren't available, people would pursue other services with potentially higher interest rates.

Two observations...
1) A "Refund Anticipation Loan" can only happen if the recipient paid too much in taxes during the course of the tax year. Otherwise there's no "refund" whose "anticipation" can be loaned against.
2) How in the hell could a loan against a POTENTIAL annual event materially benefit someone living "paycheck to paycheck", assuming the average paycheck arrives somewhat more frequently than once per year?

There was never a good reason to allow "refund anticipation loans". If there were such a reason then IRS direct deposit would certainly nibble at the margins of it, but it's hard to nibble at the margins of something that never actually existed in the first place.

Re Tom's comment, somebody who is taking an RAL probably assumes they need to enter "1" exemption on their W-4 and ends up with too much tax taken out. Other people want a refund -- it's their method of saving money by not having it to spend during the year (and at today's fraction of a percent savings rates, you're not losing much leaving it out of the bank).

I agree RALs are a bad idea, and while some people might resort to higher rate alternatives (legal or illegal) a lot will figure out how to economize -- if they money isn't there, it can't be spent.

I guess my objection to RALs is even more basic...
Let's assume that for whatever reason a refund is anticipated. It will arrive, at some point. It won't materially change the recipient's paycheck-to-paycheck existence, because it's at best an annual event. It will make the recipient feel a lot better at the moment in question. So, it needn't arrive _this_ week, it just needs to arrive. I think a RAL basically claims a huge chunk of the refund and, in exchange, moves this happy day forward a few weeks. So, instead of March being the Happy Month and February sucking, February is Happy and March sucks. It's just taking advantage of someone whose real problem is that their overall situation sucks, doing so at an insane effective interest rate, and taking relatively little risk in exchange for that rate (the genesis of this post was that the FDIC finds the loan unsafe or unsound now that the IRS doesn't actively cooperate with the scheme).

RALs do have a function for a lot of folks living check to check because of their timing. Many places used to offer a RAL when you brought in your last pay stub, i.e. the last week of December or first week in January before people get their W-2s.

First, this can cover rent and other monthly bills that people did not pay during Christmas.

Second, RALs at the end of the year were also used by low-income homeowners to pay their property tax which comes due at the end of the calendar year.

Many of RALs other uses might be less time dependent than these two examples.

It appears to me that RALs are often used to help make bigger purchases or down payments that could not ordinarily be made based on income (and savings in some instances) alone. Buy here, pay here lots sell cars with the RAL as your down payment (crazy, right?). I've also met people who use it as a down payment on rent-to-own furniture. This may not change even if their tax deductions are correct as a major part of a tax return for low-income folks comes from tax credits designed to help low-income workers or families (e.g. the Earned Income Tax Credit and Child Tax Credit) and are not dependent (I don't think) on money withheld from their paycheck.

Wingo, I agree with Tom. Why not just wait and make a bigger (sometimes substantially bigger) downpayment with your refund itself? These make you happy today but less happy in the future.

I apologize if my post was misleading. I agree that RALs make no financial sense. The only issue that I had with the comments were that time issues did play a role in folks' decisions to get a RAL (especially where rent or utilities were unpaid to afford Christmas or property taxes).

There's no doubt that people are better off using their refund rather than one of these loans. Kudos to the FDIC.

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