Jan. 13, 2011 at 9:00 AM ET
Taxpayers eager to get their refunds as early as possible have one fewer option this season -- and consumer advocates are saying "good riddance."
Tax preparation firm H&R Block won't be offering oft-criticized high-interest Refund Anticipation Loans (RALs) this season after government regulators essentially chased them out of the business. But H&R Block Chief Executive Alan Bennett has vowed to create "other financial products" to fill the void -- speculation has centered on other high-cost, short-term loan products. And chief competitor Jackson Hewitt is still offering RALs, albeit at a higher cost and with stricter standards that will lead to more rejected applicants.
Tax refund loans, which typically cost $50 to $100, have always been a bad deal -- consumers who electronically file can get their refunds free in about a week. Viewed as short-term loans, they carry an annual percentage rate that could be 250 percent or more. Still, they have been attractive to certain segments of the population, and the Consumer Federation of America estimates that 7.2 million consumers received RALs last year. It's also a lucrative business: H&R Block earned $146 million in loan-related fees last year.
But consumers groups have piled on the products for much of the last decade, pointing out the high cost and studies that show the loans are generally used by low-income consumers who can’t afford the fees and might not understand the terms.
"For a long time, banks have diverted money to their own coffers from the tax filing process. Hopefully, by next year, there won't be banks inserting themselves into the process to make money from the working poor," said Jean Ann Fox, director of consumer protection for the Consumer Federation of America. "Hopefully, this is the last year consumers will be sold these high-cost loans."
RALs were dealt a body blow in August, when the IRS announced that it would no longer provide tax prep companies with "debt indicator" data, which signaled to lenders the likelihood that all or part of a refund might be seized for unpaid taxes or other debts. Without the debt indicator, which essentially served as a credit check, banks became extremely reluctant to participate in RAL lending. HSBC, H&R Block's longtime refund loan partner, expressed its intention to discontinue the relationship. Then last month, the Office of the Comptroller of the Currency told HSBC it was no longer allowed to issue the loans, citing consumer protection concerns.
Last year, Jackson Hewitt's lending partner, Santa Barbara Bank and Trust, pulled out of the business, leaving the firm scrambling for another bank. It now has a new partner, Louisville, Ky.-based Republic Bank and Trust, but the firm has already said it can’t support the level of RAL lending from earlier years and will be capping the loans at $1,500.
A typical $1,500 refund loan from Republic will result in $62.22 in loan charges, according to the Consumer Federation of America.
Other tax preparers also offer RALs, but the number of lending partners available to them has dwindled to three, all in Louisville -- Republic, River City Bank and Ohio Valley Bank -- owing in part to increased regulatory scrutiny.
"They are not dead, but they are on life support," said Chi Chi Wu, an attorney at the National Consumer Law Center who writes an extensive report on tax refund loans every year.
Despite the high cost, many consumers found RALs attractive because firms like H&R Block were willing to roll the cost of tax preparation into the loans, meaning the taxpayer didn't have to pay anything up front for tax preparation.
Next, Refund Anticipation Checks
Tax preparation firms will fill that void with a relatively new product that already has a foothold among low-income customers — the Refund Anticipation Check, or RAC. Designed to provide taxpayers without checking accounts a landing place for refund checks, RACs are basically disposable, onetime-use bank accounts set up by tax preparation firms. A typical fee is $30. Taxpayers can receive their money in a paper check, which usually costs additional fees to cash, or on a prepaid debit card, which can also incur more fees.
Because the tax prep company controls the RAC payout, it can pull out tax preparation fees from the refund that comes from the IRS -- giving consumers the option to avoid paying for the service up front. While that might sound attractive, Wu points out that taxpayers are essentially using a short-term loan to fund their fee, meaning they might spend $30 to finance a $100 fee for two weeks -- an astronomical APR.
"There are plenty of low- or no-cost alternatives for bank accounts," Fox said. "People don't need to use Refund Anticipation Checks."
Despite the cost, RACs were even more popular than RALs last year, with 13 million consumers signing up.
Meanwhile, a new IRS pilot program make cut RAC sales off at the knees. This spring, the IRS is offering about 600,000 families the chance to receive their refunds on pre-paid debit cards (Thanks, Life Inc. Click for more details). The program is aimed at helping the estimated 9 million U.S. families who currently hold no bank accounts, If it works, it would remove one major reason consumers opt for fee-based refund anticipation checks -- though the IRS debit car program would come with its own, yet-to-be-disclosed fees.
'We've got them'
Jackson Hewitt, because it is still offering refund-backed loans, would appear to have a competitive advantage over H&R Block, and its Web site hints at that.
“Refund Anticipation Loans Available," says an ad about halfway down its home page. "We've got them. The money you need in as little as a day." While the ad also indicates that "terms, conditions and fees apply," there is no link describing the fees or conditions. A search of the site came up empty.
H&R Block has warned investors that revenue will be down this year because of its inability to make RAL loans -- some analysts say the hit could be as big as 7 percent -- but it's possible some of the lost income will be replaced by new short-term loan offerings. Trainees who attend H&R Block employment sessions are being instructed to upsell short-term loans called "Emerald Loans" offered by H&R Block Bank, according to people familiar with the training. The unsecured loans will not be backed by refunds but will be offered coincidental to tax preparation. Applicants will have to pass a normal credit check. The loans will have a term of 30 days, and will carry an APR of 36 percent on a loan of $1,000, similar to the highest rates that currently apply to other short-term loans, like credit card cash advances.
Adam Rust, who writes a blog called Bank Talk, offered a much more detailed glimpse of these Emerald Loans in a recent blog post, where he wondered if the product was "just an RAL in a green cape."
H&R Block would not discuss the possibility of a new short-term loan product.
"We continue to research and develop potential products to implement this tax season. But, at this point, we’re not at a place where we can discuss publicly," said company spokeswoman Kate O'Neill Rauber in an e-mail.
RED TAPE WRESTLING TIPS
Fox says consumers should steer clear of refund-based loans by tax preparation companies.
"Bottom line is this is an unnecessary credit product," she said. "You don't get money much faster than you do if you just do direct deposit." Improvements to IRS computer systems mean some refunds arrive in less than a week now, she said.
Refund Anticipation Checks, while less onerous, are still a bad deal, she said.
"If you're going to pay $30 for a onetime-use checking account, why not just open up a bank account you can use all year long?" she said. While larger institutions like Bank of America are clamping down on free checking accounts, plenty of small banks and credit unions still offer them.
Also, consumers with other kinds of prepaid debit cards, such as payroll cards or unemployment benefit cards, can have the funds deposited on those cards without the need to set up and pay for a RAC account.