There are a number of tax time traps you need to be on the watch for during tax season. From fraudulent communications purporting to be from official sources to scams that aim to get access to your tax refund, there are a number of traps that you can fall into this time of year.
However, one of the most devastating traps — and one of the most tempting — is the refund anticipation loan.
What is a Tax Refund Anticipation Loan?
You might see ads that insist that you can get your tax refund “early.” These ads don’t actually give you a way to get your tax refund early; instead, they provide you with a loan based on the tax refund you are expecting at some point. After your taxes are figured, a loan is provided to you, based on the refund you are supposed to be getting.
In most cases, reputable refund anticipation loan places won’t let you borrow more than you are expecting in a refund — many will loan you less than the amount that appears on your tax return. However, there are some lenders that will issue you a refund anticipation loan for more than you are expecting. You show a copy of your tax return, and you can borrow more than what is showing. In many cases, these lenders are payday lenders and similar lenders that don’t have many qualms with issuing you a glorified payday loan based on the information on your tax return.
Problems with Refund Anticipation Loans
As you might imagine, the biggest issue with tax refund anticipation loans is the costs associated with them. You will likely pay fees for your loan, as well as pay a fairly high interest rate. Indeed, the interest rates charged on these types of loans are usually higher than average rates for other types of loans. And, even if the lender claims that you have a certain period of time that you are interest-free, the origination charges or administration fees can really cut into what you take home.
Another issue might be when you have to repay the loan. In some cases, you are required to repay the loan within a few weeks, since your tax refund is expected. That can be a problem if you are getting the money because of a long-term financial problem. Another issue might be that you won’t get the refund you expected. If you made a mistake in figuring out your tax refund, or if you are audited, you could find yourself owing in taxes — as well as being required to repay the loan.
Refund anticipation loans are tempting because the promise you access to money right now. However, this can be a costly tax time trap. Especially since you can receive your tax return quite quickly if you follow the right steps. If you file electronically, and if you indicate that you want to receive your tax refund via direct deposit, you can receive your tax refund in as little as seven days — without paying loan fees or interest. These days, technology has sped up the process of filing your taxes and receiving you money back. There’s no reason to get a costly refund anticipation loan.
Miranda is freelance journalist. She specializes in topics related to money, especially personal finance, small business, and investing. You can read more of my writing at Planting Money Seeds.