Pay-stub Loans Prove to be Risky Business for You

Consumer advocates are not pleased about a new loan that financial institutions have tied to tax refund and which hit the market long before tax season arrived.

Called 'pay-stub' loans, the way this works is that consumers can get an early refund based on their last paycheck. Mind you, there is a disparity between the traditional refund anticipation loans and the pay-stub loans, in that the traditional loans are not available until late January or early February when employers send out W-2 forms reporting final earnings, taxes already withheld and other necessary information.

As a way to meet holiday expenses, tax preparers started promoting the loans in November instead of waiting until the beginning of January, which is the month when most pay-stub loans are prepared. As a result of that, Americans should expect to see a radical change in sales from the loans, says Chris Keeley, a spokesman for Neighborhood Economic Development Advocacy Project.

According to consumer advocates, pay-stub loans are too expensive, and offers more risk than the traditional refund loans. One way they are risky is that the absence of a W-2 form increases the chance of basing a loan on incomplete or missing information. For example, a tax preparer may not be aware of an IRS lien on the refund to pay child support, a student loan debt, or a client's other sources of income.

Tax preparers and banks disagree by saying that pay-stub loans are good in that they provide consumers with more choices to receive funds, and that there are no hidden costs and the conditions of the loans are fully open to the consumers. Fritz Elmendorf, a spokesperson for the Consumer Bankers Association, points out that the loans are expensive for banks because of their short-term life, their small amount, and their no credit check policy. Elmendorf does agree though that the consumer should be made aware of all the terms of the loans.

HSBC bank says that they make sure people are not only informed about the terms and costs of the loan, but that consumers receive prices that are reasonable.

According to Internal Revenue Service (IRS) data, they reported that 12 million American taxpayers paid more than $1 billion in fees for traditional refund anticipation loans in 2004. As of yet, there are no statistics available on pay-stub loans.

For the low-income tax filer who qualifies for the Earned Income Tax Credit, the refund anticipation loan can be harmful. Taxpayer advocate Nina Olson reports that there is an advantage to delivering the tax credit to beneficiaries without fees being taken out of it.

Fees are charged for pay-stub and traditional refund anticipation loans yearly, which can be extremely expensive. Because pay-stub loans must be paid back with a "balloon payment" in February, many tax filers who use them make the payment by taking out a traditional refund anticipation loan, which has additional expenses.

Let's say, Keeley said, a pay-stub loan for $1,500 which was prepared by one tax preparer costs about $85. If the tax filer later returns to the same preparer for traditional refund anticipation loan to repay the pay-stub loan, and raise the loan to $2,000 an additional $150 is charged, for a total of $235.

Whether or not the tax filer receives all his refund, with a pay-stub loan or a refund anticipation loan, he is responsible for paying back his loan in full.

Loan product (Holiday Express Loan) makes sure consumers receive information on other available options. For a loan of $600, the bank will charge $65.

According to H&R Block, their pay-stub loan product (Instant Money Advance Loan) is cheaper than other company's products, and that they give clients what they need to make informed choices.

For the entire month of January JPMorgan Chase will be offering pay-stub loans for the first time, and according to bank spokesman Tom Kelly, the bank will make sure that consumers know what the costs are.

Kelly concludes by saying that there is a little more risk connected with pay-stub loans, but for consumers who want to receive their refund two to four weeks earlier than usual, then this is the way to go.

Earnest Young is a tax and accounting writer for Accent Accounting and Taxes, http://accentaccounting.net/

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