Monday, December 23, 2013

Cash advance offer. Good or bad?

I am sure many of us who have received this offer from your 'friendly & caring' bank, myself included. The offer would sound something like "this facility provides you cash now for a low interest rate of 9% per annum, which is much lower compared to your credit card's interest of 18%"

Most people heard the 9% vs 18% and immediately conclude it is a good offer, but is it really? No, it is NOT! I took the carrot sometime mid this year, with the intention to settle my credit card at one go. But now about 6 months down the road, after some thinking and calculation, it was not a very good decision, despite whatever the telemarketeer tells you. 

The following is the explanation:

Assuming you take RM5,000 cash advance (Cash Treats, EZcash, etc.. all same thing) with a 9% per annum interest, with RM100 processing fee and no early settlement fee, sounds good right? So it worked out as per below:

Initial amount 6,000
Interest 540
Processing fee 100
Total to pay  6,640

But what if you charge that amount to your credit card, but you plan (with good discipline) to pay the bank RM500 every month off the principal amount (RM6,000) plus whatever interest the bank charges for that month on that principal. Assuming 15% p.a. interest rate, which most people with good payment record get from their bank.
Month Balance Amount off the principal Interest Total amount to pay
1 6,000.00 500.00 500.00
2 5,500.00 500.00 68.75 568.75
3 5,000.00 500.00 62.50 562.50
4 4,500.00 500.00 56.25 556.25
5 4,000.00 500.00 50.00 550.00
6 3,500.00 500.00 43.75 543.75
7 3,000.00 500.00 37.50 537.50
8 2,500.00 500.00 31.25 531.25
9 2,000.00 500.00 25.00 525.00
10 1,500.00 500.00 18.75 518.75
11 1,000.00 500.00 12.50 512.50
12 500.00 500.00 6.25 506.25
6,000.00 412.50 6,412.50

Notice the LOWER total amount to be paid, within the same number of repayments, despite the supposedly higher interest rate? This is because the cash advance above calculates interest based on total amount, while the credit card calculates interest based on balance remaining! 

So be careful of such offers. Longer repayment period or more cash advance amount will naturally just make the difference even bigger! If you're planning to take cash advance, or already taking one, it would be a good idea to fully settle it soonest. 

Now you (and I) understand why the banks keep on offering such offers with the impression that it's the bank that's losing i.e. lower interest + no charge for early settlement. Apparently, it's not really to our benefit. Well, we should not trust the bank too much in the first place, they're in the business to make profit anyway...


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