Wednesday, January 9, 2008

Why Tax Refund Loans Make Bad Financial Sense

It's getting to be tax season which means a slew of tax preparation companies will spring into action and in the process begin to push tax refund loans on consumers. Reports state that nearly 12 million Americans take companies up on these offers -- and fatten the bottom lines for return preparation companies in the process.

There are a few factors at work here. The first is that people love receiving tax refunds. However, say you receive a $2,150 refund. The important thing to remember is the government is really just returning the excess money you paid over what you owe. It's not free money -- its your money that you just gave to the government interest free for a year. Second, what the tax preparation companies tend not to advertise is that these loans are similar to payday loans and charge APR's often in excess of 100%. A $100 finance charge on an average refund of $2,150 has an APR of 178%.

If you are receiving a large refund you've already given the IRS a good deal, don't give the tax preparation firm an even better deal. If you use a tax refund as a way to force yourself to save money open an online savings account (ING, HSBC, and E*Trade all are easy to use and allow you to link multiple accounts). Take the amount of taxes you owed the previous year, divide by 12, and set up an automatic savings plan with the online savings account to regularly deduct a portion of that amount out of your checking monthly, weekly, or bi-weekly. This way you don't make an interest free loan to Uncle Sam and you are able to actually earn some interest yourself in an FDIC insured account.

Read more about Refund Anticipation Loans @ Wikipedia

Image: RBereig @ Flickr