Big tax refunds: An opportunity to leverage for the future

Imagine living on $11 an hour and raising two children. That’s less than $23,000 a year before taxes. Will you have two nickels to rub together most days, never mind enough cash to treat the kids to something nice now and then?

Now imagine that each February, you get about $7,500 direct deposited into your financial institution – or onto a pre-loaded card if you don’t have a credit union or bank account. What do you think you’ll do next?

Tusculum University and ACFCU partnered to provide free
tax return prep for 735 taxpayers through VITA in 2018.

Here in Central Appalachia, plenty of people don’t have to imagine that scenario. At Appalachian Community Federal Credit Union, we’ve seen firsthand plenty of families whose situations mirror the scenario above. Our partnership with Tusculum University has helped us serve hundreds of low and moderate-income taxpayers annually through the IRS-sponsored VITA (Volunteer Income Tax Assistance) tax prep program.

Many VITA clients get sizeable refunds bolstered by the Earned Income Tax Credit (EITC). When we ask how they’ll use their refunds, they often tell us they’ll catch up on delinquent car payments, fix a car or try to buy a new car. That vehicles are often part of the conversation is unsurprising considering that in Appalachia most people who work need cars.

That experience jibes with a 2008 study by Andrew Goodman-Bacon and Leslie McGranahan of the Federal Reserve Bank of Chicago (see it here). But their rosy assessment may miss some nuances we see working with low- and moderate-income families on an everyday basis.

 

Opportunities like ACFCU's First Time Borrower Program
can help people access affordable vehicle financing while
they work with financial coaches.

“Our primary finding is that recipient household spending in response to EITC payments is concentrated in vehicle purchases and transportation spending,” the pair wrote in their conclusion.

So far, so good. Then comes this sentence: “Given the crucial link between transportation and access to jobs, we believe this finding is consistent with the EITC’s goals.”

I can’t argue with that, but it leaves out one important point: Many families who qualify for EITC have poor credit scores and/or limited access to fair lending. When that transportation spending lines the pockets of predatory lenders, sometimes the long-term benefit for EITC recipients falls prey to unintended consequences – and quite frankly, to the financial system that has established itself so firmly in our society. It can even create a cycle in which, vehicle-wise, folks know the feeling of getting a car repo’d better than they do the feeling of paying off a car loan.

We encourage VITA clients to consider a financial assessment with us so they can find a way to leverage that kind of money for their long-term benefit. Why do we do that? Often, our large-refund taxpayers have poor credit scores. If they’re lucky, they might be able to finance a car with a high-interest subprime lender such as Santander and get a 25 percent rate. Or they might simply finance at a “buy-here, pay-here” lot and pay 35 percent or more.

Let me put it to you using some total interest paid and monthly payment numbers for an $8,000, 48-month car loan:

·       $311 a month, $6,964 interest paid (35 percent)

·       $265 a month, $4,732 interest paid (25 percent)

·       $202 a month, $1,739 interest paid (10 percent)

Mary Robinson, her husband and their two daughters
are about to move into their own home. The Robinsons'
car loan is at a great rate. Financial coaching was key.

If you bring home, say, $1,700 a month, think what a difference $100 of extra cash flow can make! We’ve found that clients who stick with coaching for the long-term raise their credit scores by an average of well over 150 points, which can often put them in line for those lower rates.

With good coaching, that cash flow gets put to good use in establishing savings, knocking down debt levels and keeping things moving in the right direction. We have clients who make less than $30,000 a year, yet through taking the right steps and accessing the right opportunities, they have 700-plus credit scores, affordable vehicle financing and even mortgages!

As I wrote in last week’s post on financial health vs. financial literacy, helping people move the needle positively is an intensive, long-term process. We believe the “tax refund windfall” offers an excellent opportunity for people to establish a baseline and begin that process. Until we learn otherwise, we’ll keep testing that belief.

(Jeff Keeling is vice president of communications and community relations for Appalachian Community Federal Credit Union.)