Why Tax Refund Anticipation Loans are Bad for Credit

If you are thinking about a tax refund anticipation loan, they may not be the helpful financial tool you have been led to believe they are. While they are touted as being an interest-free way to get earlier access to your tax refund money, they have some hidden dangers that can end up causing more harm than good. Understanding these potential pitfalls lets you know what to look out for if you are considering one of these loans and can help you avoid the potential ding to your credit that a tax refund anticipation loan can cause.

What is a tax refund anticipation loan?

It is a short loan provided based on the estimated amount of your tax refund.

Who gives tax refund anticipation loans?

They are offered by third-party providers, not the IRS. Some common providers of tax refund anticipation loans include tax preparers and short-term (payday) lenders.

How do tax refund anticipation loans work?

You borrow the anticipated amount of your tax refund from the lender, who then gets repaid that amount directly from your tax refund.

What if the anticipated amount of your tax refund is not the same as the actual amount of the tax refund?

If your tax refund ends up being larger than the anticipated amount, then the lender will provide you with a check for the difference. However, if your tax refund is smaller than the anticipated amount, then you are on the hook to the lender for the difference.

Why do people get tax refund anticipation loans?

The main reason that people get these loans is that they have bills to pay and do not want to wait the additional few weeks until their income taxes can be processed.

Are there fees or interest associated with tax refund anticipation loans?

There could be. Even if these loans are labeled as zero-fee or zero-interest, there may be fees associated with processing your tax return or if the refund amount is less than the amount of the loan. You need to carefully read any terms and conditions associated with these types of loans. Things to look for include check-cashing fees, high interest rates, and e-filing fees.

Are refund anticipation loans the same as refund anticipation checks?

Yes and no. When a tax preparer offers a refund anticipation loan, it is called a refund anticipation check. Because the companies are responsible for determining the amount of your tax refund, these checks are generally lower risk than if you use other lenders to secure a refund anticipation loan. They are also less likely to contain hidden fees or interest.

How are refund anticipation loans bad for your credit?

Anything that causes you to spend unnecessary money is bad for your credit. There are plenty of services that will help with tax preparation for free and completing your income taxes before the April 15th deadline usually results in a refund that is handled promptly, especially if you choose direct deposit. Of course, the biggest risk is that you will borrow too much, which could trigger high interest rates and even potential default. Many companies also require credit checks.