It's no surprise that tax season is fast approaching. Although owing money can be stressful, people who receive refunds might find tax season a time to plan big purchases such as new furniture or electronics. Many people use their tax refunds to go on a vacation. Every year, millions of households receive money back from their tax returns. According to the Internal Revenue Service, 96,274,000 households got a refund on average of $3,039 for the 2021 tax year. These numbers are quite different from the $2,827 average refund received by 95,632,000 households the previous year. This is despite refunds being made of consumer money and that they are a sign that someone has given an interest-free loan the government. A large number of Americans choose to get their refunds quicker by using a tax refund loan. BackgroundGetty Tax return check on 1040 Form backgroundGetty Before we get into the negatives of tax refund loans, let me explain how these loans work. Tax refund loans, also known as "refund anticipation loans", are short-term loans that use your tax return amount as collateral. You can usually apply for a loan to pay off your tax refund with your tax preparer after you have filed your tax return. This will allow you to get your money immediately.
Nearly all the major tax filing firms offer refund anticipation loans every year. Terms can vary. Although some refund anticipation loans offer better deals than others, they are not risk-free and are often loaded with fine print and hidden terms. Michael P. Griffin, a professor of finance and accounting at University of Massachusetts Dartmouth, said that refund anticipation loans have the most negative aspects. He says the fees and fine print can make them costly. Jackson Hewitt offers an example of an Early Refund Advance Loan. The annual percentage rate for this tax refund anticipation loan is 34.22%. There is a finance fee of 6% on the loan amount. The Financial Industry Regulatory Authority, (FINRA) states that some refund anticipation loans may have additional fees that are not obvious. Griffin states that in addition to paying unnecessary fees, there is also the possibility of a delayed or reduced tax refund due to various reasons. For example, if you believe you are getting $3,000 back, but your tax refund ends up being $2,000, then you will be responsible for the difference. Griffin adds that critics claim tax refund loans can lead to a cycle of debt for taxpayers already in financial trouble. To get a large refund next year, they might choose to keep the same amount of withholdings from the paycheck. You should not apply for refund anticipation loans to avoid paying high interest and reading fine print. To avoid paying extra fees, you should search for tax refund loans without additional charges. Griffin suggests that there are other options to avoid taking out a refund anticipation loan. These include saving money throughout the year for unexpected expenses, and looking into alternative funding sources. You can adjust your withholdings on your paycheck to increase your access to your hard-earned income over the long-term. While this will lower your tax refund in March and April each year, it can also improve your cash flow.