What Is an Income Tax Loan and How Does It Work?

FT Contributor
A woman signing an income tax loan form while a financial advisor points where to sign.

For most people, filing taxes means getting a refund. Tax time comes but once a year, but what if you need your refund from the IRS sooner? If you can’t wait on your tax refund, a tax refund loan might be the answer. Officially known as a refund anticipation loan (RAL), a tax loan is based on the amount of your income tax refund. You can obtain a tax refund loan from small financial institutions and sometimes even your tax filing service. These loans may be approved in a short amount of time with no credit checks, but the lender will ask for information from the IRS.

Tax loans are short-term solutions that typically only last a couple of weeks. This is just long enough for the IRS to process your refund. Tax refund loans are for the value of your refund minus any interest charges or other fees. Regardless of whether your refund covers the amount of the loan, you are still responsible to repay the balance of the loan in full. If you have bad credit or don’t submit the proper forms, you may be denied a tax refund loan. Similarly, if your income was too high or too low during the fiscal year, you may be turned down for a loan. Learn more about how income tax loans work and where you can get one yourself.

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What Is a Tax Refund Cash Advance Emergency Loan?

This is another name for an income tax loan. Some companies may refer to this name over the other, but they are virtually the same kind of short-term loan. You can receive a loan for the amount of your tax return in very little time and with very little effort.

How Do Income Tax Loans Work?

Income tax loans are like an advance on your tax refund. If you need the money right away, a tax specialist can give you an advance. Because it is a loan, you are charged interest on the amount you borrow. Fees may be taken out as well, depending on the lender. When the IRS processes your tax refund check, it gets deposited into the lender’s bank account. If your refund is less than estimated, you are still responsible for repaying the full amount of the loan.

Advantages of Tax Advance Loans

If you need your tax refund before tax season is over, a RAL can help. As with many short-term loan options, there are a number of advantages to taking out a tax advance loan. If you need money now, a tax refund loan gets it to you fast because your tax refund serves as a guaranteed source of collateral. There are no titles to these loans and you don’t have to schedule out payments. Once the IRS processes your refund, the loan is repaid a long as you can cover the accrued interest. In addition, tax advance loans offer the following benefits discussed below.

  • If you file early in the tax season and claim the Earned Income Tax Credit or the Additional Child Tax Credit, you have to wait longer than usual for your refund. Tax advance loans can help you get your refund sooner.
  • No credit check is required. Because your loan is based on money that the government is already guaranteeing you, you don’t have to jump through a bunch of hoops to obtain a tax advance loan.
  • You can get cash quickly and easily. If you’re going through a family emergency or simply want to add to a dwindling emergency savings account, a tax advance loan can help you get the cash you need when you need it.

Disadvantages of Tax Advance Loans

Tax advance loans can get you the money you need quickly, but there are a few disadvantages associated with this type of short-term loan. Before you decide to take out a tax advance loan, it’s important to weigh the pros and cons. Consider the following disadvantages before you take out a tax advance loan.

  • Tax advance loans can be expensive. Interest rates are often high and fees related to obtaining a tax advance loan are often set at a higher percentage of the overall amount you’re being lent. A RAL loan could have an annual percentage interest rate higher than 200%.
  • You could lose out on most of your refund. Depending on the lender, you can lose anywhere between 10% and 60% of your refund to cover the cost of a tax refund loan.
  • You risk lowering your credit score. While there’s no credit check required to get a tax advance loan, you run the risk of significantly lowering your credit score if you don’t make payments on time. In addition, if you miss a payment, you could be turned over to collections, which is an even bigger problem to deal with.
  • If you or your tax preparer make a mistake and calculate an incorrect return, a tax refund loan can become a major problem. In addition to owing the lender, you could owe the IRS far more money than you would have had to pay initially.

Where to Get an Income Tax Loan

You can get a loan through a tax professional either in person or online. H&R Block offers a Refund Advance, which is basically a short-term loan worth a certain amount, depending on what your refund is supposed to be. Unlike some institutions, H&R Block doesn’t charge interest or fees, but they do require that you file in person with an H&R Block representative. Note that you have to pay for their tax-filing service, so if your refund isn’t substantial, the loan might not be worth the hassle.

Other financial institutions such as TurboTax offer similar solutions digitally. When e-filing your taxes, you can opt into the cash advance option and then fill out a loan application. Again there isn’t any interest or fees charged on this loan, but it’s important to note that your refund will arrive on a prepaid card, which can take up to 5 to 10 business days after the IRS accepts your tax return. If you file online with the IRS, you could have your refund just as quickly, if not quicker than the time it takes to file with a tax preparation service and apply for a tax refund loan. Therefore, it’s important to carefully consider your needs and the turnaround time of the institution you’re working with.

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