Often, people pass off the seeming lack of logic concerning the use of refund anticipation loans as evidence that the poor make poor decisions, or that they fail to understand the time value of money.
When described by academics, there's even a name for people who exhibit this kind of decision-making: they are individuals with a "high discount rate." What this means is that the poor, in this example, value money in the present greatly. They would take a dollar today over a much higher amount in the future.
The price of a RAL, where an APR can be over 200 percent, infers a very high discount rate. We are talking about people who might take $1500 tomorrow (you have to wait one day to get your refund with a RAL), rather than waiting to get $1700 in about ten days.
I think the mechanics of a RAL tell us that this academic description of how the poor are making decisions is a little bit off the mark.
Borrowers who get RALs avoid paying for their tax preparation services out of pocket. It might cost them $150 otherwise to get taxes done at one of the mainstream franchise tax prep services. That can be a lot of money to a person trying to support a household on a minimum wage salary.
Here's how the conversation might go:
Tax prep guy: Your return is ready. You are going to get $1,700 back. Do you want to pay me now, or in two weeks? If you pay me later, I'll just take it out of your refund. It's really easy.
RAL candidate: Uh, that sounds pretty simple to me. I'll pay you later.
Let's assume that the RAL candidate is operating with a good understanding of how much a RAL is going to cost. That is a big assumption, considering how clear it is that many people do not have a strong financial education. In that somewhat optimistic scenario, the RAL applicant might realize that it's a very costly convenience to get the RAL. That person might have explored options for credit to be had elsewhere.
That is the rub. Because in the most optimistic scenario, what this tells us is that there is little recourse to find credit elsewhere for these poor consumers. It reflects very poorly on our credit providers. The only loan product that could be more expensive might be a payday loan. Even credit cards would be far better - suggesting that for many of these consumers, credit cards are out of reach.
Looking at the RAL decision from a less rosy viewpoint will lead you to an even darker conclusion. Then, the RAL is going to someone who does not understand the full implications of their choice. That points to a lack of transparency. It's a situation that borders on coercion.
What is revealed is a situation that is aptly characterized as extortionate.
Let's play this out in the context of another product, almost as ubiquitous as cash and definitely something that you would have a "high discount rate" for in the event that you were caught without any of it.
Imagine if you ran out of gas. The gas in this case represents cash.
You walk to the gas station.
The attendant notices that you are on foot. He says, "gee, I just raised the price on my gas. Today, my gas is $20 a gallon. Sorry. I think I will have gas in two weeks for $1.99. Do you still want some fuel?"
Oh, yeah, that would be irritating.
But then the guy behind the counter goes on. "Gee," he says, "I'd be happy to pump your gas for you right now."
He is so nice that you almost feel like you can ignore the fact that you know that you are completely being taken for a ride. Hopefully, you think, he'll just stop coming up with ways to take advantage of me. Oh, but he has more to say.
He looks at you as he walks out in the parking lot to the gas pump. "Oh," he says, "where are you going to put it?"
You are not feeling good about this.
"No gas can..Tsk Tsk," he says. "That is a very big problem, for you. I feel bad that you don't have a gas can. I have gas cans. Today, they are specially priced - $20 per quart container."
I'm not joking. You do have to get someplace to put your fuel (cash). The RAL providers will give you a card to hold your loan advance. You have to buy it, though.
You are probably ready to never walk into this gas station again, at least after you walk out with some fuel. You are at the pump. You're thinking, just give me the gas. I'm your punk, fine, but we're not going to be meeting any more.
That's why you are not happy when he turns around again.
"Sir, Do you want a spout, too?"
Oh, and let's assume you want a spout. Hard to walk to your car when half of your quart of gas has spilled on to your clothes or dripped into the pavement. Even harder to pour the gas into your tank. Somehow that Coke bottle on the side of the street seems like an inadequate substitute. You need that spout.
"Today," he says, "you are lucky. I can provide a spout, to you, my customer. It is only going to be $19.95."
Guess what? Your RAL provider wants to sell you a spout, too. That is, if you want to use your card, there's often a transaction fee - you know, to get your fuel (cash) out of the container. Of course, this container is especially lame, because it also has a special charge if you want to check your balance or add money to it later at an ATM.
Yep, this is about the problems of credit for people who have no other options. It shows you how tough the system can be when you are out of the banking system. Some should just get into banking, but others face legit obstacles. That's for another blog, but believe me, there are a lot of them out there.
Either way, looking at RALs closely leads one to the conclusion that they are a real problem.