What to know before you take an advance on your tax refund

  • In 2017, taxpayers took out more than 1.7 million so-called refund anticipation loans, or RALs, up from 1.5 million the year before, according to a 2018 report from the National Consumer Law Center.
  • Demand could be higher this year as a result of the government shutdown.
  • Yet refund-advance products can carry high fees, and consumer advocates warn they should be used only as a last resort.
The Internal Revenue Service (IRS) headquarters in Washington, D.C.
Janhvi Bhojwani | CNBC
The Internal Revenue Service (IRS) headquarters in Washington, D.C.

Getting an advance on your tax refund may seem like a more attractive proposition this year — yet it's not a move to make lightly.

A growing number of consumers have been using financial products at tax time that promise to advance them part of their tax refund. In 2017, taxpayers took out more than 1.7 million so-called refund anticipation loans, or RALs, up from 1.5 million the year before, according to a 2018 report from the National Consumer Law Center. (Another 20.5 million obtained a refund anticipation check, or RAC, up from nearly 19 million in 2016. Such transfers don't speed up your refund, but rather act as a loan of the tax prep fees, which the preparer deducts from the refund when it arrives.)

Part of that swelling demand stemmed from new anti-fraud regulations that took effect last year, delaying refunds until mid-February for consumers claiming the earned income tax credit or the additional child tax credit.

This year, experts say, the ongoing government shutdown could generate even more interest, both from affected workers who are running low on financial resources, as well as other taxpayers who worry about refund delays tied to the shutdown and implementation of the new tax rules.

The IRS said last week that income-tax filing season would begin on Jan. 28 as planned, and that it would pay refunds to consumers in spite of the shutdown. But tax pros have expressed doubts that the season will go off without a hitch.

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Consumer advocates generally don't like refund-advance products, due to both high costs and the potential for scams. And because the IRS often issues refunds quickly (by its own estimations, in less than 21 days), it's usually a better idea to steer clear, said Bruce McClary, a spokesman for the National Foundation for Credit Counseling.

"The situation is complicated this year because of the government shutdown," he said. "It does put a fly in the ointment of all the advice we've given in the past to just sit tight instead of taking an advance."

"There are a lot of people living on the edge right now," McClary said — and for many of those consumers, a tax refund is a substantial check.

Here's how to navigate the field:

Analyze borrowing costs

If you're leaning toward a refund-advance product, do thoroughly investigate the price tag at various preparers before you schedule a tax-prep visit.

Today's refund-advance products are largely different than those available years ago, which advocates had warned of as "high-cost, high-risk loans." National tax chains, in particular, tend to promote their offerings as free advances.

Just because a refund-advance product isn't called a loan, or doesn't have an interest rate, doesn't mean it's free, said Scott Astrada, director of federal advocacy at the Center for Responsible Lending. Carefully read the terms and conditions, and ask plenty of questions.

"Do a rigorous assessment of what the cost is," Astrada said.

"It takes just one payday loan that's unaffordable to trap you in a debt cycle," he warned.

Depending on the product and provider, there could be fees for applying for the advance, checking your credit and transferring the money to you, said tax attorney Kelly Phillips Erb of Taxgirl.com. Last year, the National Consumer Law Center estimated, costs for a refund anticipation check ranged from $29 to $65 for a federal refund, and up to another $10 for a state refund. Attached products such as a prepaid debit card typically carry plenty of fees, too.

"You get eaten up by paper cuts," she said.

Then there are fees related to preparing and filing your tax return, which might be more than what you could otherwise pay if you weren't focused on finding a tax preparer who could offer an advance, said Erb, who is also a managing attorney at The Erb Law Firm in Paoli, Pennsylvania. Many of the consumers who use refund-advance products could qualify for the IRS Free File programs.

"It's a loan in anticipation of you getting a refund at a certain time. You want to make sure you're not signing up for something that's tying you to an unanticipated government schedule." -Kelly Phillips Erb, Tax attorney

With concerns of refund delays, pay particular attention to product terms that hinge on timing, she warned. You'd want to know if there are fees or a penalty APR that kick in if circumstances delay the arrival of that refund (and in turn, your repayment of a loan).

"It's a loan in anticipation of you getting a refund at a certain time," Erb said. "You want to make sure you're not signing up for something that's tying you to an unanticipated government schedule."

A shutdown-related refund delay doesn't release you from an obligation to repay that loan within the agreed-to timeframe, she said — or keep the lender from tacking on interest or fees for those extra days the government keeps you waiting.

Compare other options

Once you have a sense of the cost of a refund advance, compare it to other financial products available to you, said Astrada. Paying a $35 refund anticipation check fee to defer a $350 tax preparation fee for two weeks is equivalent to a 174 percent APR, points out the National Consumer Law Center.

"Shop around as much as possible to the options that are open," Astrada said.

Many community banks and credit unions offer small-dollar, short-term loans, he said, and those terms may be less expensive and friendlier overall. Consumers with good credit may find that personal loans or zero-percent credit card offers are worth assessing as a short-term bridge, too.

"The situation is complicated this year because of the government shutdown. It does put a fly in the ointment of all the advice we've given in the past to just sit tight instead of taking an advance." -Bruce McClary, Spokesman, National Foundation for Credit Counseling

If you're worried about a particular bill, being proactive with creditors could also help you reduce the need for a refund advance or avoid one altogether, McClary said. Utilities are often willing to offer no-cost or low-cost extensions, and medical providers may be able to set up no-cost payment plans

(Furloughed federal workers in particular may be eligible for special-rate loans, waived fees and other aid.)

Slashing your budget or selling unneeded items could also help generate a little income to bridge the gap between filing and receiving your refund, McClary said.

"That can help give you some breathing room," he said.

Be alert for scams

Plenty of suspect practices can tie into refund-advance products, Erb said. You could have your personal information or your tax refund stolen, or end up with a penalty-laden tax headache to unravel.

Make sure you use a reputable tax preparer, and check credentials and references before you hire them. Red flags would include a preparer who charges fees based on the value of your refund, or who says your refund will be deposited in their bank account (versus your own, or a temporary one set up to handle a refund anticipation check).

One common scheme in this area is falsifying elements of a return to maximize the refund (and so, the advance). For example, claiming head of household status or an education credit when you're not entitled to, she said.

"I get tons of emails where people are incentivized to lie to boost a refund to get a refund loan, and think they'll just fix it later," she said — but that's not easy, or cheap. "Now you're going to have to pay the IRS interest and penalties, and it creates a mess."