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4 key questions to ask when considering a cash advance

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4 key questions to ask when considering a cash advanceA credit card cash advance is like grocery shopping at a convenience store: handy but expensive. It's not surprising, then, that recession-bitten consumers are turning away from cash advances. 

That's a good thing, financial experts say. Except in the most dire of emergencies, cash advances are a bad financial idea.

"That's your highest-risk money, when someone's using their credit card as an ATM," says Mark Berg, president of Timothy Financial Counsel, a Wheaton, Ill.-based financial planning firm.

Advances, essentially loans from your credit card issuer, are easily available in two ways: via an ATM or by cashing a convenience check. But you pay for that convenience with high fees and compounded interest rates that soar into the double digits. While some offers come with low introductory, or "teaser" rates, they can seduce consumers into a false sense of security, adds Heidi Albert, president of School2Life.com, a Chicago-based company that teaches money-management skills to young adults.

"They say, 'They wouldn't have given me the money if they thought I couldn't pay it back,'" she says.

Becoming much less popular
Given these lean economic times, it's not surprising that cash advances have fallen out of favor. Usage dropped 35.6 percent during the first quarter of 2010 over that same period in 2009, according to payment industry newsletter Nilson Report. The decline marks the latest plunge in a downward trend, says Nilson Report publisher David Robertson.

There are plenty of possible reasons for the decline. First, they're very expensive. According to David Jones, president of Association of Independent Credit Card Counseling Agencies, a nonprofit credit counselor accrediting group based in Fairfax, Va.:

  • Interest rates on cash advances average from 1 percent to 7 percent higher than a card's standard purchase interest rate. That means if your card's standard APR is 15 percent, you could pay up to 22 percent for cash advances.
  • The average cash advance fee is $10 to $20. That's on top of any interest rate charged. 

Worse, consumers who take out cash advances usually give up their grace period -- the period during which, on ordinary purchases, consumers can use their credit cards without incurring any interest charges, as long as they don't carry balances. With a typical cash advance, interest is charged from the moment the cash is withdrawn. 

Jones says those cash advance interest rates top 40 percent, depending on the cardholder's creditworthiness. That's going to drive away consumers, who since 2008 have been less willing to take on credit card debt, even if it comes with reasonable terms. "Even people who are creditworthy, who have jobs, aren't borrowing money," Robertson says.

Another reason: Given the recession, credit card issuers are skittish about high-risk customers -- and most cash-advance customers fit that description, Robertson says. "They're falling -- from creditworthy into something else," he says.

He adds that terms of the Credit CARD Act, the majority of which took effect in February of 2010, make it more difficult for card companies to penalize consumers who default on their loans. In other words, cash advances -- a key revenue stream for credit card issuers -- are becoming less profitable.

Yet he doesn't think the decline signals the death of cash advances. "It's a cycle," Robertson says. "Americans are working their way through deleveraging, and credit card issuers are figuring out how to work through the CARD Act."

Not always a bad choice
As unwise as cash advances are, financial advisers say there are times when they might be an acceptable financial choice.

One is when you're looking for a very short-term loan.

J. David Lewis, a financial planner who lives in Knoxville, Tenn., plans to use a cash advance from his MasterCard to buy a used video camera for his 26-year-old son, a professional photographer who doesn't have a credit card.

His son plans to buy the camera from an individual, not a store, and needs to use cash. Without his own credit card, the son has few options. "The market doesn't have a lender for that, and if it does, you wouldn't want to cross their door," Lewis says. His son will write the monthly checks to the credit card issuer to repay the loan, a strategy Lewis hopes will introduce his son to the habit of borrowing money and repaying it in a timely fashion.

Lewis has done the math: Using a promotional deal on his MasterCard, the $2,000 cash advance will cost $2,114.74. That's the amount of the advance, an $80 fee and a month's worth of interest at 4.99 percent. He says the interest and fee will be reasonable -- that is, if his son pays the loan back within a month. Lewis is keeping his fingers crossed. "Cash advances work if you have the discipline to pay it off. If you don't, the penalties are pretty high," he says.

A dire emergency -- say your car has broken down, the mechanic will only take cash and you don't have your ATM card in your wallet -- can also make a cash advance an acceptable alternative.

Even then, "think twice," says the AICCA's Jones. "It ought to be a last resort." Berg, with the Timothy Financial Counsel, agrees, saying he'd rather see clients who need money sell a few belongings than get a cash advance.

What to consider before getting an advance
With that caution in mind, Jones suggests four questions to ask before getting a cash advance:

  • Can I pay the money back in a month? That's the only way to minimize sky-high interest rates, Jones says, adding that there's really no way around the fee card issuers charge for cash advances.
  • Is there any other way to deal with this financial situation? Consider all options -- even borrowing money from a family member, Jones advises. "The only worse place is a payday loan company," he says.
  • Do I really need what I'm about to buy? "Impulse buying is a habit more than anything," Jones says. Need a car battery on a winter day, and the dealer won't take a credit card and you forgot your ATM card? Go ahead. A pair of Jimmy Choo shoes? That brand-new iPhone? Think again.
  • Do I need help? The typical cash advance customer is a cash-crunched customer in need of a financial makeover. "They ought to be thinking about lifestyle changes," Jones says.  

Indeed, too many dips into the cash-advance waters should spark a drastic lifestyle change, says Berg. "Think of what you can't live without, wait a month and see if you're still alive," he says. "Cash advances go against the core philosophy of living within your means."

See related: A guide to the Credit CARD Act, Fed report: Consumers remain less willing to take on credit card debt 

Published: July 8, 2010


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