Refund Anticipation Loans

There has been interesting news in the tax preparation world this week. The Office of the Controller of the Currency (OCC) announced on Christmas Eve that it was directing HSBC Bank not to fund any refund anticipation loans for H & R Block in 2011. Accordingly HSBC cancelled their contract with HRB, leaving Block without a provider for the coming tax season.

Since the ability to provide refund anticipation loans (RAL) to tax clients was a major marketing tool for Block, this is considered a body blow to the company. Shares of HRB dropped almost 8% when the news was announced.

A RAL is a short term loan made at the time a tax return is filed. The size of the loan is usually the calculated amount of the refund, less tax preparation fees, interest, and charges. Basically, the tax client signs over their IRS refund to the bank making the loan. When the IRS sends the refund to the bank, the loan is repaid. With electronic filing, the time the loan is outstanding averages about 10 days.

H & R Block bent over backwards to prevent this from happening. The company even offered to cover any credit losses that HSBC would have had, making the loans essentially risk free. Since the OCC did not change their position, I have to conclude that protecting the integrity of the banking system was not driving the regulatory action. This looks like a politically driven decision, based on consumer protection arguments.

Consumer protection activists dislike RAL’s, because the loans have very high calculated interest rates. This is because the $29.95 charge to process the loan is added to the actual interest charges, then divided by the length of the loan to determine the APR. For an example, let’s suppose you borrow $2000 at a 24% interest rate for 10 days. The interest charge would be about $13. A high interest rate, but the overall bite of $13 bucks isn’t too bad.

Now, add in the $30 loan processing fee to the $13, and work the calculation backwards. That calculation is $43, divided by $2000, times 36. That comes out to just over a 77% annual percentage rate.

Your outrage over this depends a lot on how you look at the transaction:
Outlook I
“I’m going to loan you money and charge you 77% interest.” “That’s usury! You’re no better than a loan shark!”

Outlook II
“I’m going to loan you $2000 for one to two weeks, and it will cost you $43.” “That doesn’t sound so bad, and I’d like to get the money as soon as I could. I’ll take the deal.”

In point of fact, millions of tax clients took the deal every year. Now they will be “protected” from making this choice by the OCC.