When the bills are piling up, it’s not always easy to make good financial decisions. But even if you feel like you need to get your hands on some cash in a hurry, don’t jump at the easiest opportunities. If you make a bad choice, you might find yourself deeper in debt. Some options you should avoid when you’re in this situation are: consolidation loans, payday lender prepaid cards, and tax refund anticipation loans.
Certain bank subsidiaries and consumer finance companies lend money in the form of consolidation loans. With a consolidation loan, you roll multiple older debts into a single new one that, ideally, has a lower interest rate than your existing debts. Then, your monthly payments are lower, freeing up cash for other uses.
Sometimes, a consolidation loan is a personal loan. Other times, the lender requires you to put up your house or car as security, which means the loan is just like a second mortgage or a secured vehicle loan.
Here are some of the reasons to avoid consolidation loans:
In a typical payday loan transaction, the borrower either:
Example. Suppose you give a payday lender a postdated check for $300. The lender then gives you $250 in cash and keeps the remaining $50 as its fee. The lender holds the check for a few weeks, until your payday. At that time, the lender cashes the check to repay the loan. But if you can’t cover the check, the lender charges you another fee ($50 in this example). Now, you owe the lender $350—the $250 borrowed plus the first $50 fee, plus a new fee of $50.
Here are some of the reasons to avoid payday loans and payday lender prepaid cards:
The bottom line is that a payday loan is a very pricey way to borrow money and using a prepaid card makes the transaction all the more expensive. Even if you’re desperate for money, you should generally steer clear of payday loans and payday lender prepaid cards.
Although getting your tax refund as soon as possible can be a good way to get cash, you should avoid refund anticipation loans (RALs) and refund anticipation checks (RACs).
A RAL is money borrowed from a payday lender or other nonbank lender based on your anticipated tax refund. RALs can be extremely expensive. For example, in 2015, the Consumer Financial Protection Bureau (CFPB) found that one RAL lender had annual percentage rates (APRs) of over 240%. Another charged fees that amounted to APRs as high as 218%. The U.S. military classifies RALs as a type of predatory loan and prohibits interest rates above 36% for servicemembers (and their dependents) who are on active duty for at least a month.
Major banks and tax preparers stopped offering RALs in 2012 due to a regulatory crackdown. However, as of early 2018, RALs are making a comeback in the tax preparation industry. The RALs offered by tax-preparation firms loans are fee-free with 0% interest—but the tax preparers use them to cross-sell other services, like the provider’s tax preparation services, which can cost hundreds of dollars. Or the loan might get loaded onto a prepaid card that charges fees.
Refund anticipation checks (RACs) are a method used to deliver tax refunds and pay for tax preparation services. RACs are also sometimes called “refund transfers.” Many tax preparers offer RACs for those who can’t afford to pay a tax preparation fee up front.
With a RAC, the lender opens a temporary bank account and the IRS directly deposits the refund into the account. The tax preparation fee comes out of the refund when it arrives, along with perhaps other fees, and you get the amount that’s left over. (Some companies require you to put the remaining part of the tax refund on a prepaid card. To review the disadvantages of using prepaid cards, see above.) The company then closes the account.
RACs are usually very costly. For example, if it costs you $35 to defer paying a tax preparation fee of $350 for three weeks, the APR would be 174%. Extra fees that are added to the tax preparation fee—like “document processing” fees, “application” fees, or “technology” fees—can range from $25 to several hundred dollars, and can significantly increase the cost of a RAC.
In most cases, you can file your return electronically and get the money within a week or two by having the refund deposited directly into your bank account, for example. Be aware, though, if you claim the Earned Income Tax Credit (EITC) on your tax return, the IRS will not issue your refund until February 15 at the earliest. This applies to the full refund, even the amount that is not associated with the EITC. In some cases, it's a good idea adjust your tax withholding to give you more money each payday instead of having to wait for the tax refund.
Low- and moderate-income taxpayers can get help with taxes from the Volunteer Income Tax Assistance (VITA) program, AARP’s Tax-Aide, and the online Freefile. Some free tax preparation programs can also help you open a bank account into which your refund can be directly deposited.
For answers to tax questions, contact the IRS at 800-829-1040 (voice) or 800-829-4059 (TTY), or visit the IRS website. You might also consider talking to a tax attorney.