The digital age has seen credit cards slowly eclipse other forms of payment. The ease of use and access to ready money has made it an indispensable part of most of our lives. Credit cards, if used wisely, help tide us over in the event of unexpected emergencies. They also serve as a way to defer payment in the case of big-ticket purchases. Most cards also come with a host of rewards and perks that encourage us to spend. The picture stays rosy as long as the card bills are paid off at the end of every billing cycle or in instalments.
Cash Advances- What are they?
Credit cards are now increasingly being used for other purposes, such as a cash advance. A cash advance is a feature that allows the cardholder to withdraw cash against the credit limit on their card. The amount that can be withdrawn as a cash advance is a portion of the available credit limit, usually up to 40%.
Cash advances can be availed through an ATM, with the cardholder able to withdraw up to the cash advance limit as and when he/she desires the funds.
A cash advance provides easy access to emergency funds, so cardholders need not rely on payday loans or loan sharks if they need cash urgently. So why are financial advisors cautioning people against using this feature?
High Charges on Cash Advances
One of the main reasons financial advisors caution individuals against taking out cash advances are the fees and charges associated with them. A cash advance is one of the most expensive services that credit cards offer, and using this service will result in the charges racking up.
A cash advance attracts a transaction fee, which can be between 2-5% of the total value of the amount withdrawn. Some banks and credit card companies have a fixed fee, for example Rs.200 per cash advance taken out. Others charge either a percentage of the amount withdrawn or a fixed fee, whichever is higher.
For example, a cardholder withdrawing Rs.10,000 as a cash advance could be charged a transaction fee that is 5% of the transaction, which would be Rs.500. This would be a fixed fee over and above other taxes applicable, such as GST.
Thus, the cardholder would end up paying a significant amount towards charges and fees.
A cash advance results in a whole host of other charges. Since the money has to be withdrawn from an ATM, there are ATM charges for such a facility. Not using an ATM operated by the same bank increase these charges, making a cash advance an even more expensive option.
Cash advances are also subject to limitations and withdrawing more than is allowed would also incur a cost and further charges. Overstepping a credit limit or exhausting too much of an open line of credit attracts penalty charges and also signals to the bank/credit card company that the cardholder is likely to default on bill payments.
No Interest-Free Period
Credit cards offer cardholders an interest-free period within which they can pay off their outstanding balance without any charges. These interest-free periods range from 40-60 days and enable cardholders to clear their card bills. Failure to do so would attract interest on the outstanding amount.
In the case of cash advances, however, there is no interest-free period. The cardholder would be charged interest from the date of withdrawal of the cash advance. The interest rate on a cash advance is also higher than the rate applicable for other purchases, thereby increasing the cardholder's debt.
Thus, not paying off a cash advance would only result in the cardholder sinking deeper into debt and could result in a default on the credit card bill. This would negatively impact the cardholder's credit score and be symptomatic of a larger problem.
Increases Overall Card Debt
Taking out a cash advance when the cardholder hasn't paid off outstanding debt on the card presents another problem. For example, if you have an outstanding balance of Rs.5,000 on your card and you take out a cash advance of Rs.10,000, you effectively have to repay Rs.15,000. If you choose to clear this off in instalments, you will be charged interest on the cash advance amount till the whole amount due is paid. This is because of payment allocation. While ideally debt with a higher interest rate is to be paid off, the bank may clear the smaller outstanding debt amount first. This means your cash advance will keep accruing interest until the entire amount (Rs.15,000) has been paid off.
No Purchase Protection
While this is considered a minor drawback when it comes to cash advances, it remains relevant. Using cash instead of a credit card for a purchase means the item is not covered under purchase protection. Purchase protection provides some relief to the cardholder in the event of the purchased item being stolen or damaged. When it comes to large purchases, this can prove to be a godsend. However, using cash withdrawn from a credit card to make such a purchase negates this additional coverage.
Taking out a cash advance should be avoided at all costs, if possible. While a cash advance can be used as a last-ditch option to secure emergency cash, it should be used only when all other alternatives have been exhausted. Possible alternatives such as borrowing from friends or family or requesting an advance from an employer could be considered.
A cash advance can be a better idea when compared to borrowing from a moneylender, for example. However, there is a possibility that the amount paid as interest when taking out a cash advance could be as much as the amount charged by a loan shark or moneylender.
So before you swipe that credit card at an ATM in a quest for some quick cash, be sure to weigh the pro's and the significantly longer list of cons to make sure you won't end up burying yourself in card debt.