I had the unfortunate opportunity to learn how cash advances on credit cards work. The particular card I saw was from Capital One, but I think they all work the same. There are three important things to know about cash advances:
- The interest rate is huge – usually in the mid-20% neighborhood
- Interest starts on the day of the advance – no grace period like with purchases
- Payment are applied to the purchases first, then cash advances, even if the purchase occurs after the statement date
I knew about points 1 and 2. I did not know about number 3. Even knowing 1 and 2, I still would not have discouraged this person from getting a cash advance, because I know she pays off her balance every month. Capital One can charge 25% or 50%, what difference does it make. She’ll pay the balance at her next statement and she’ll have some small interest due. Except for #3. Number 3 ensures that she will be paying interest on that cash advance for the rest of her natural life.
I should mention that I still discourage taking cash advances on credit cards. Even without #3, my friend, who works at Crediful, says that it’s better to get your cash in other ways. But if you’re out of town and lost your ATM card and can’t get to a bank branch – in other words it’s a freakin’ emergency and there’s no other way – then I would have said ‘Go for it’. Now I know that there is no situation so dire that you should take out payday loans or a cash advance on your credit card. Go find a pawn shop and borrow money from a loan shark – it’s cheaper.
Based on the three points above, I was wondering how long it would take to pay off the cash advance. The interest on each statement is not that big. If you’re the type of person who carries a balance, you probably wouldn’t even notice that some of the finance charge is coming from a cash advance. Thankfully, this person has zero finance charges every month, so it was pretty easy to spot.
Here’s the scenario: A person spends $100 per week on his credit card and pays the balance every statement. Statements cut off on the 18th of the month and payment is due on the 28th. On January 15th, in addition to the normal $100 per week, he takes a $500 cash advance. How long will it take to make the cash advance balance zero? The answer is never. Under these conditions, the cash advance balance will never be zero. Let’s check out the model.
Column B: The total payment made – always the statement balance. On 1/28/2010, $601.02 is paid because that’s the balance on the statement date.
Column C: Purchases made – $100 every 7 days. A little contrived, but what can I do.
Column D: The amount of column B that the credit card company applies to purchases. On 1/28/2010, they apply the payment to the purchase balance on 1/27/2010 – not the purchase balance on the statement date.
Column G: The amount of column B that the credit card company applies to cash advances. Even though the whole $501.02 of cash advances from the statement date was paid, only $401.02 is applied because there were purchases in the interim.
Column H: The daily interest on cash advances. There is no interest on purchases because we pay the whole balance every month. The interest rate is in H1.
Note that I’ve hidden some rows in the above image. The next payment, 2/28/2010, is applied 100% to purchases and the cash advances balance just keeps growing. Ten years later, the $502.17 payment reduces the cash advance balance to $100.70. Ten years later! In the mean time, the total interest paid was $260.11 on a $500 cash advance. Pathetic.
Everything in this model is pretty solid. I don’t cover the 3% gouge he got when he took the cash advance. And the $100 per week is an average spending pattern that’s been rigidly applied. I wonder what would happen if I made the spending habits a little more random.
The formula in C4 is =IF(WEEKDAY(A4)=6,100,""). Let’s see what happens when I change it to =IF(RANDBETWEEN(1,7)< =3,RANDBETWEEN(25,40),"").
Here are the results for 10 recalcs
| Recalc | Total Spent | Interest Paid | Payoff Date |
|---|---|---|---|
| 1 | 52,123.00 | 40.19 | 2/28/2013 |
| 2 | 51,387.00 | 135.89 | >10 years |
| 3 | 51,407.00 | 32.04 | 11/28/2015 |
| 4 | 50,193.00 | 34.50 | >10 years |
| 5 | 51,178.00 | 40.03 | 2/28/2016 |
| 6 | 50,042.00 | 56.51 | 11/28/2014 |
| 7 | 50,747.00 | 46.82 | 4/28/2018 |
| 8 | 51,115.00 | 146.92 | >10 years |
| 9 | 51,138.00 | 128.33 | >10 years |
| 10 | 48,546.00 | 117.30 | >10 years |
In a lot of cases, the only way to get rid of the cash balance is to stop using your card for a while.
You can download CashAdvance.zip.
You obviously don’t read the terms and conditions to know about #3.
Knowing how it works, if you MUST take a credit card cash advance, you have to calculate the interest accrued since the statement date and the payment date, add a good safety margin, at least 10%, and then pay that amount regradless of the statement amount. If you use the card monthly, the overpayment will get absorbed the following period.
But, as you rightly note, it is a mug’s game and quite honestly, is clearly a casewher government should legislate. It is immoral, besides being grossly inflated rates, it plays upon people’s lack of knowing the allocation rules, an inability to realise that the bill is actually higher than the statement, and an inability to calculate that increase.
Thankfully, I can say that I never knew this. But, prior to this post – I wouldn’t have been against doing it, in say, an out of town need like you stated.
Most people are unaware, including myself, of point #3.
Thanks for this information.
The only caveat is that the purchase balance would have interest applied at a different rate. Additionally, you need to show the number of days in the billing cycle.
There’s no rule stating you can’t make a payment at any point during the month. If you must take a cash advance, send in a payment as soon as you can. Add a couple of percent extra as a safety next and you’ll be fine, except for the 3-5% fee you were soaked with at the beginning.
Of course, that’s assuming you’re not already carrying a balance. If you are already carrying a balance, you can still indicate which balance you want your payment applied to. It defaults to paying off the balance that makes the least for the bank, but if you tell them to apply it to the cash advance balance first, they have to honor your request.
While the most efficient way to handle this is not using the card for anything else until its balance returns to zero for two statements (so not use it for 3 months), the other alternative is paying off the loan (that’s what a cash advance is) as soon as possible, then pay it off again. That is, pay enough so you achieve a credit balance. Yeah, you overpay, but you ensure you end the loan payments. At least the overpayment applies to your subsequent statement balance.
In the U.K. the offers are for very low interest rates on balance transfers from other cards. As discussed already you still pay the big % rates on anything else you put on, and it is those purchases that get paid off first.
I have enough trouble with the small print from I.S.P.’s. £6 a month for broadband and phone*!!!
(for the first 3 months, then £14.99 a month thereafter, requires a telephone line at £11.49 a month).
My old man (who can count then number of times he has used his credit card on one hand) not only paid his balance in full (when he had one), but always sent in a few cents extra. That meant that the credit card company was always in debt to him. This torqued them off to no end, and they were always sending him notices to stop it. They even cut him a check for seven cents once (which he never cashed just to keep it on their books awhile), but he immediately sent them a “payment” of eleven cents (which the processing department dutifully deposited) that started the cycle all over again.
On February 17th 2010, the rules change. The new rule is that payments over the minimum due will be applied to the charges that incur the highest interest rates. Since rates on cash advances are typically higher than that of purchases, payments made after the 17th will pay down the cash advance balance first.