Nearly one in five tax filers getting a refund this tax season, many of whom number among the working poor, are expected to use a refund anticipation loan (RAL) or refund anticipation check (RAC), a new Urban Institute study estimates. A related study investigates how state regulations affect consumer use of payday loans, auto title loans, pawnbroker loans, RALs, and rent-to-own transactions.
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WASHINGTON, D.C., February 25, 2011 -- Nearly one in five tax filers getting a refund this tax season, many of whom number among the working poor, are expected to use a refund anticipation loan (RAL) or refund anticipation check (RAC), a new Urban Institute study estimates.
Many of these 20 million filers will turn to these devices because they need money fast to pay bills, especially from holiday shopping; others need part of the expected tax refund to pay for tax preparation.
Just 20 percent of the nation's communities account for nearly 70 percent of all RALs and RACs, the study determined. In many very poor neighborhoods, RALs and RACs account for more than 40 percent of all returns with refunds.
RALs were created in the 1980s as short-term bank loans secured by the taxpayer's expected refund. RACs, a slower and lower-cost alternative to RALs, are used mainly by those lacking bank accounts; a RAC sets up a temporary account for direct-deposit refunds.
Using Internal Revenue Service data , the researchers found that, of the 111 million tax filers with a refund for tax year 2008, 8.4 million (7.6 percent) took out a RAL and another 11.6 million (10.5 percent) received a RAC.
The working poor are the heaviest users of RALs and RACs, the researchers found. One in four refund-receiving tax filers earning $10,000—$25,000 uses a RAL or RAC. Those earning below $10,000 are not the biggest users, because their income is too low to generate a sizable refund or they receive the maximum earned income tax credit (EITC).
The research -- presented in "Who Needs Credit at Tax Time and Why: A Look at Refund Anticipation Loans and Refund Anticipation Checks" -- was funded by the U.S. Department of the Treasury. The study was conducted by the Urban Institute's Brett Theodos, Rachel Brash, Jessica Compton, Nancy Pindus, and Eugene Steuerle and the IRS's Karen Masken.
More Key Findings
- RAC and RAL users are fast filers: they apply for 83 percent of RALs and 56 percent of RACs by the third week of February. Just 20 percent of other tax filers with refunds get their returns to the IRS by then.
- The median refund for RAC recipients is $2,703; for RAL recipients, it's $3,577. The median amount for taxpayers who get a refund without a RAL or RAC is $1,526.
- Congressional efforts in 2006 to shield military families from predatory lending led to a major shift from RALs to RACs. In 2005, 168,200 members of the military used a RAL and 221,900 used a RAC. By 2008, the respective numbers were 15,700 and 335,400.
- Communities in Appalachia and the Deep South have high rates of RAL and RAC use, while many northern communities use both options less frequently. The study documents use for every state, the District of Columbia, and the top 100 metropolitan areas.
- Just a little bit of interest or dividend income (a signal an individual is likely to have a bank account) is linked to tempered RAC and RAL use. Twenty-five percent of those without any such income use either product. The figure drops to 7.2 percent among those in the $1—$49 bracket and 4.5 percent for those in the $50—$250 group.
- Half of EITC recipients with qualifying children took out a RAL or RAC (26 percent for RALs and another 23 percent for RACs).
- Single adults with one or more dependents stand apart: 4 in 10 of these head-of-household filers receive a RAL or RAC, versus less than 1 in 10 married filers.
In their report, the researchers review many policy options -- involving regulations, prohibitions, fees, competition, consumer education, disclosures, IRS operations, and more -- that can affect the demand and supply of RALs and RACs and their pricing. "The clear policy implication is that policy interventions that go well beyond RAL/RAC use, such as efforts to get people banked, may be among the most important interventions of all," they conclude.
2nd Study Zeroes in on States and Alternative Financial Services (AFS)
RALs and RACs are among the short-term, high-cost products existing side-by-side with pawnshop loans, auto title loans, payday loans, and rent-to-own arrangements. Although often small in amount initially, these types of credit can add up to significant debt burdens for many poor and low-income households that use them.
Another new study -- "Prohibitions, Price Caps, and Disclosures: A Look at State Policies and Alternative Financial Product Use" -- investigates how state regulations affect consumer use of payday loans, auto title loans, pawnbroker loans, RALs, and rent-to-own transactions. The study was funded by the Treasury Department and conducted by the Institute's Signe-Mary McKernan, Caroline Ratcliffe, and Daniel Kuehn. They used data from the FINRA Investor Educational Foundation's 2009 National Financial Capability State-by-State Survey.
The research team found that between 6 and 13 percent of respondents used each of the five AFS products from 2004 to 2009. AFS customers, in contrast to nonusers, tended to be lower income, without a bank account, younger, less educated, minority, financially responsible for more children, and southern.
"Prohibitions, Price Caps, and Disclosures," which includes state data on product use, shows that AFS use varies widely by state. For example, 24 percent of residents in Arizona and Wyoming used a pawnshop loan in the past five years; only 3 percent of Vermonters did.
Pawnshop loan users, the researchers found, are younger than auto title loan or payday loan users. While 49 percent of pawnshop loan users are younger than 35, 38 percent of auto title loan users and 37 percent of payday loan users are under 35. Auto title loans are taken out by higher income families than other alternative financial services. While 53 percent of pawnshop loan users earned less than $25,000, 31 percent of auto title loan users earned below $25,000.
Price caps and prohibitions on AFS products can reduce supply, the researchers observe. "Restricting supply can increase well-being when it restricts or exposes high-priced suppliers who might be offering products at well-above-market prices," they note. "At the same time, restricting supply without introducing alternative products can reduce consumer well-being, as consumers turn to inferior products or options to deal with credit needs."
Prohibiting payday loans is associated with a 35 percent decline in such borrowing. People who live near another state can cross state lines to obtain a loan. Also, Internet payday loans are generally available to people in states that prohibit payday lending businesses.
Moving from having no annual percentage rate (APR) cap on auto title borrowing to setting a 36 percent APR cap (the federal cap on payday loans to the military) is linked to a 30 percent reduction in use. And moving from no interest rate cap to roughly a 40 percent APR is associated with a 25 percent reduction in pawnshop borrowing.
The Urban Institute is a nonprofit, nonpartisan policy research and educational organization that examines the social, economic, and governance challenges facing the nation. It provides information, analyses, and perspectives to public and private decisionmakers to help them address these problems and strives to deepen citizens' understanding of the issues and trade-offs that policymakers face.