Refund Anticipation Loans Are Killing Us

It's tax season in the U.S. again and I'm glad to be involved with a group offering VITA (Volunteer Income Tax Assistance) for low and moderate income households as a part of my internship with the International Rescue Committee. The VITA program is vital to the most successful poverty alleviation program the Fed has found so far: the Earned Income Tax Credit. When I was working with ACCIÓN USA I had the good fortune to be present at the first convening of the Atlanta Prosperity Campaign's Earned Income Tax Credit (EITC) task force and I'm glad to see that the campaign is in full swing a few years later.

You might recall that we've discussed the EITC a few times here on the blog.

It's been credited as very successful in assisting those of low and moderate incomes to develop assets, that is, wealth building.  

Started in 1975, the Earned Income Tax Credit is a refundable federal tax credit designed to reduce the tax burden on low- and moderate-income workers and encourage participation in the labor force. In 2006, EITC benefited 22.4 million people with an average credit of $1,951. Research has shown that the EITC is often used to pay off debt, but it can also present an opportunity for wealth building.

I copy + pasted the last three sentences from a study recently released from the Woodstock Institute, a Chicago-based research and policy organization. They go on to point out that the "primary consumers of Refund Anticipation Loans (RALs) are recipients of the Earned Income Tax Credit. According to the National Consumer Law Center, 63 percent of the 8.67 million people who received a refund anticipation loan in 2007 also received the EITC."

RALs are those loans that tax prep sites (like H&R Block, Liberty Tax, Jackson Hewitt, etc.) offer to folks that want their tax return refunds ASAP. As they state:

While RALs give borrowers rapid access to their tax return, they do so at a significant cost to borrowers. According to a February 2009 report on the RAL industry produced by the National Consumer Law Center and the Consumer Federation of America, fees for a RAL in 2007 ranged from $104 to $111 per loan, with an average fee of $107.50. Lenders charged additional fees to borrowers who wanted their loans processed in one day. These costs are substantial when considering the size of the loan. For a refund anticipation loan of $3,000, annual percentage rates (APRs) ranged from 77 to 140 percent. On top of these RAL fees, an estimated 20 percent of RALs included additional application fees which can add another $40 to the cost of the loan. In addition, borrowers pay tax preparation fees that average as much as $183 at one nationwide vendor.

They then quote the National Consumer Law Center study that states that, "EITC recipients generated $525 million in fees for refund anticipation loans in 2002." Then citing a Brookings Institute study stating, "the complexities of the EITC qualification and application process appear to drive low-income taxpayers to use paid tax preparers. The means by which tax preparers are compensated for generating RALs rewards steering. A tax preparer is compensated for each loan they generate, and in some cases receive additional bonuses for meeting the quotas of the lender."

The Woodstock researchers point out that there is evidence for a motivation toward tax fraud present in these Refund Anticipation Loans, "In 1994, the IRS estimated that 92 percent of fraudulent returns filed electronically involved refund anticipation loans. In an effort to reduce fraud, the IRS stopped providing tax preparers with information on outstanding tax debt, a function called the Debt Indicator. Both RAL volume and RAL fraud dramatically declined after the elimination of the Debt Indicator. However, the IRS reinstated the Debt Indicator in 1999, after which RAL fraud rates increased."

So who are the folks making these RALs possible? According to the National Consumer Law Center it's: JP Morgan Chase (with 13,000 independent tax preparers), HSBC (H&R Block's RAL provider), and Pacific Capital Bancorp - the parent company of Santa Barbara Bank & Trust. According to the NCLC's recent press release, "RALs drained the refunds of about 8.4 million American taxpayers in 2008, costing them in the neighborhood of $738 million in loan fees, plus over $68 million in other fees." It's obviously popular to complain about the Wall Street Bailouts, but here is an annual bilking of Main Street.


Weirdly, the IRS doesn't require any kind of regulation of tax preparers, until this year, as the NCLC reports this year, "On January 4, 2010, the Internal Revenue Service (IRS) announced its plans to finally regulate the tax preparation industry. Currently, most tax preparers are not subject to any sort of licensing, competency or minimum educational requirements, a fact long criticized by consumer advocates and others, such as the National Taxpayer Advocate."

While it would be great if the EITC was used to build assets among those that qualify, the reality is that the recipients are often on the business end of a host of predatory lending practices (such as RALs, Title Loans, Pay Day Loans, Check Cashing services, Rent-to-Own schemes, etc.) and so the monies that are allocated with EITC are usually spent servicing debts. As the National Consumer Law Center points out, if you're considering a debt repayment program, caveat emptor (buyer beware):

[D]ebt settlement companies usually take out all of their fees, ranging from 14 to 20 percent of the total debt, within the first half of the contract. For debts totaling $20,000, a consumer could pay fees of $2,800 to $4,000.

"Debt settlement companies usually collect most or all of their fees from consumers long before they have eliminated any of their debts, and consumers pay these high fees regardless of whether their debts are settled or not," said Susan Grant, Consumer Federation of America’s Director of Consumer Protection.

"There is no guarantee that your debts will be settled," said Gail Hillebrand, Financial Services Campaign Manager at Consumers Union. "The industry’s own statistics show that debt settlement doesn’t eliminate all of the debt for most consumers. The full fee can be deducted from your savings even if you are still stuck with your debts."

The drop-out rate for debt settlement services is very high; a study of one company’s customers revealed that 60 percent had cancelled within 5 to 6 months after starting debt settlement. Claims for success rates can be very misleading because they often don’t take into consideration the cost of the fees consumer pay or the size of those debts that are never settled.

The NCLC is an excellent source for those of us that don't have much money and don't know how the credit and financial systems are set-up (and how they're predisposed to bleed us).