Mark Winslow, a medical physicist from Upland, Calif., was in no rush for his refund when he walked into H&R Block a couple of years ago to have his taxes prepared. So he declined the tax preparer's offer of a so-called quick loan to tide him over until the Internal Revenue Service check arrived.
"I thought the interest rate was outrageous," Winslow, 37, said of the annual interest rate of more than 19 percent, on top of a processing fee.
Such loans, he added, don't make sense if a taxpayer is expecting a refund within weeks. "It preys on poor people who need money the most," he added.
But millions of Americans lack Winslow's patience and buy pricey refund-anticipation loans, or RALs, instead of waiting for their free IRS checks.
Consumer advocates have warned taxpayers for years about the loans that, they say, drain millions of dollars out of U.S. tax refunds each year.
Indeed, 8.4 million Americans took out RALs in 2008, costing them $806 million in interest payments and fees, according to data recently published by two consumer advocacy groups; the Consumer Federation of America and the National Consumer Law Center. RALs often carry annual percentage rates as high as 500 percent, according to the law center, with an average RAL of $3,300 carrying a rate of 72 percent.
Refund-anticipation lenders often target low-income taxpayers, especially those who receive the Earned Income Tax Credit, according to the IRS. About 1 in 17 tax returns filed in 2008 involved a RAL.
"Refund-anticipation loans are extremely expensive and unnecessary loans that draw millions of dollars away from consumers," Jean Ann Fox, director of financial services at the Consumer Federation of America, said. "If you file your return electronically and get it deposited directly into your bank account, you can get all of your refund in less than two weeks, instead of sharing some of it with a banker."
Refund-anticipation loans are perfectly legal and offered by a wide range of national companies, including H&R Block, Liberty Tax and Jackson Hewitt.
Because tax preparers lack licenses to make the loans, they usually partner with large banks such as HSBC and JPMorgan Chase.
Kate Rauber, a spokeswoman for H&R Block, said that "not all RALs are created equal," adding that her company has taken several measures to improve service in recent years.
For example, she said, H&R Block has sharply cut prices and its average refund loan of $3,000 now carries an APR of 33 percent.
"These charges are similar to a convenience fee," Rauber said, referring to the $29.95 refund account fee and interest rates that H&R Block charges. "How many of us have paid expedited shipping fees to get something faster we ordered online?"
Tax preparers offer customers no-fee options during their appointment and inform clients five times of costs associated with RALs before they're asked to sign on the dotted line, she said.
Sheila Cort, a spokeswoman for Jackson Hewitt, said that RALs may be an "effective option to address a specific, timely individual need," adding, however, that many clients also choose cheaper alternatives, including the IRS' free direct deposit.
As is often the case with pricey financial products, RALs are often bought by consumers who might be desperate for cash or unaware of how the IRS operates.
Many users simply don't know that the IRS doesn't charge for electronic filings or direct deposits, and that they will usually receive their refunds in full within two weeks.
The loans aren't the only problem, according to the National Consumer Law Center. Americans also spent $360 million in 2008 on what the group considered unnecessary refund products, such as temporary bank accounts offered by tax preparers for a fee of $30 a piece.
RALs allow tax preparers to hide how much they are really charging for tax preparation because preparation fees are usually taken out of the loan in advance, consumer advocates say.
"This is an easy way for them to obscure how expensive tax preparation is because if you don't have to take the money out of your billfold or write a check, you might not notice how much you paid," Fox of the Consumer Federation of America said. "It enables tax preparers to charge a multiplicity of fees and hide what the total cost is going to be."
In some cases, borrowers are drawn to these refund aids because they don't have a bank account, Consumer Reports senior editor Tobie Stanger said. H&R Block even sells a pre-paid MasterCard, the Emerald Card, which gives unbanked customers a way to receive their refunds.
H&R Block spokeswoman Rauber said the card helps customers save check-cashing fees. The card is free as long as customers keep using it, she said. Once it has been inactive for 90 days, however, H&R Block begins deducting a monthly $2.50 "inactivity fee" unless customers cancel the cards.
Companies such as H&R Block, Jackson Hewitt and Liberty Tax are accustomed to fighting off complaints from consumer advocates. All three firms have been sued over RALs, both by state attorneys general and private lawyers.
California Attorney General Jerry Brown won a $1.3 million lawsuit last year against Liberty Tax and settled for $4.85 million with H&R Block over what he called misleading advertising about refund loans.
"Liberty Tax Service's print and television ads misled customers by promising, 'Most refunds in 24 hours,'" Brown said in a news release announcing its victory. "In reality, Liberty was selling refund-anticipation loans, not a tax refund."
His predecessor settled a similar lawsuit with Jackson Hewitt in 2007 for $5 million.
Although H&R Block and Jackson Hewitt did not admit to any wrongdoing in their settlements, the scrutiny from regulators has already yielded some changes.
Many tax preparers have toned down their advertising and cut their prices. An average loan of $3,300 now carries an APR of 72 percent and costs about $65 instead of the $100 charged two years ago.
In addition, increased publicity about the drawbacks of RALs and the growing popularity of volunteer tax preparation networks such as the IRS Volunteer Income Tax Assistance Program have helped to shrink the number of RALs sold each year.
RALs peaked at 12.4 million loans sold in 2004 and fell steadily to 8.7 million in 2007 and 8.4 million in 2008, according to the National Consumer Law Center.
Further declines may be in the offing, Fox of the Consumer Federation of America said, noting that Jackson Hewitt's ability to offer loans recently received a blow.
The U.S. Office of the Comptroller of the Currency prohibited Santa Barbara Bank & Trust, one of the country's largest RAL lenders, from making any loans during the 2010 tax season.
The bank provided about 75 percent of all RALs sold by Jackson Hewitt, the country's third-largest tax-preparation chain, Fox said.
The office would not comment on why it blocked the 2010 loans. But consumer advocates have welcomed the news.
"There is good news in the fight against RALs," the Consumer Federation of America and the NCLC wrote in news release, urging regulators to prohibit any new banks from issuing RALs. "Taxpayers can save themselves loan fees altogether by just saying 'no' to quick-refund loans."
But not all customers frown on RALs. Chrissy Rauls, 27, an administrative assistant from Pascagoula, Miss., said she needed some extra money to buy Christmas gifts when H&R Block offered a loan, which she thought was a good deal.
"I think it was actually a good thing for me because I knew I was getting a large refund this year and they took the money I owed for the anticipation loan right out of my tax refund," she said, adding that she paid $90 in fees and interest on a $900 loan.