Monday, June 21, 2010

Why Are Cash Advances so Expensive?

My primary credit card charges 24.99% APR for cash advances and 9.99% APR for purchases. Unlike purchases, cash advances have no "grace period," meaning customers are still charged interest even if they pay off their bill in full every month.

Both transactions involve borrowing money from the credit card companies: one for purchases and the other for cash. Yet the companies encourage the former while strongly discouraging the latter. Why?

When consumers swipe their cards at stores, the credit card companies charge the merchants an interchange fee, typically 2% of the value of the transaction. When someone gets a cash advance, there is no merchant to pay the fee. The credit card company needs to make up this money somehow to remain profitable; thus, they charge a higher interest rate.

If there were a grace period for cash advances, they would amount to interest-free loans. Customers could deposit their cash advances into interest-earning saving accounts and then return the money before the end of the month. Many customers would max out their credit to take advantage of this risk-free profit opportunity (also known as arbitrage), as credit card companies watched their losses mount. Eliminating the grace period for cash advances is one way to prevent such behavior.


Phil Birnbaum said...

"If there were no grace period ..."

I think you mean "if there were A grace period ...".

Greg Finley said...

Right. Will fix. Thanks!