Editorial Policy

Income swings require budgeting, not cash advances

Erica Sandberg

June 30, 2015

QHi Erica,

As a new (this year) self-employed contractor, I get paid sporadically in different amounts. Sometimes I get large checks and other times I get nothing at all for over a month. It's been very hard to manage my bills with this type of cash flow and have depended on my two credit cards more than I probably should have. I recently had to go to Atlanta and had no money in my bank account, so I took a cash advance of $400 to tide me over. I already had $1,000 on this card. I intend pay it all off with my next big check, but I'm worried about my credit. Just how bad is this? I've done it more than a few times, and am worried I'm wearing out my welcome with my credit card companies. Thanks. — Juliane

ADear Juliane,

It can be challenging to cover regular expenses with a fluctuating income. Hang on for some tips about how to manage them, but first to address the matter of depending on credit cards when funds run low. As a rare solution and when you can satisfy the balance quickly, extracting cash from a credit card account can be fine. However, it's easy to begin to depend on this method during lean times. If it becomes a habit, big balances are not far behind.

You see, cash advances are particularly perilous because of their fee structure. Issuers charge about 5 percent interest immediately upon withdrawal and interest begins to assess immediately. For the $400 you recently received, that fee was probably only about $20, but between the fees and interest, a cash advance balance can get out of control rather quickly.Ask Erica

For example, let's say you have a bad month or two and don't have enough cash to meet your essential expenses, totaling $3,000. Take it from your card and the fee will be nearly $150. Worse, there is no grace period, so interest begins to accumulate on the advance increased by the fee right away, and often at a higher rate than for purchases.

So stop relying on cash advances now, and do follow through on your plan to pay the entire balance off as soon as possible.

As far as your credit rating, the algorithm used to create credit scores does not differentiate between cash advance debt versus purchases debt. However, you will be downgraded if you owe too much in relation to the credit line or start to skip payment deadlines, both of which can happen if you descend into deep debt. And while issuers are often happy to provide a cash advance option to cardholders, they might roll up the welcome mat if your credit scores plummet.

Now, there are several ways to establish a healthy personal finance routine for inconsistent cash flow, but this is what works for me. Try it, then tweak it to meet your own style.

  1. Estimate how much money you spend annually. Make a list of all expenses, from the necessary (such as housing, transportation and groceries) to the discretionary (such as gifts and vacations) and periodic (new tires, home maintenance, etc.). Divide that number by 12 to get a monthly breakdown.
  2. Project annual pre-tax income. This is what you will earn for the entire year. Be conservative. If it's more, great, but don't count on it.
  3. Estimate your tax liability. Skim the right percentage from your earnings for taxes, and deposit it into a separate account. Pay your quarterly taxes on schedule. Visit IRS.gov for details and forms. Now divide your after-tax income projection by 12 for a monthly income.
  4. Subtract your monthly expenses from your estimated post-tax monthly income. Hopefully you will have more than enough to cover your bills, but if not, consider ways to make up the difference. This could be taking on more work or paring down spending.
  5. Deposit net earnings into a checking account and parse it out as per your budget. After routing cash into an account for taxes, you'll be left with what you need to live on. Resist the urge to spend more than what you've decided to part with, as you will come up short when the next month isn't so flush. Set aside extra cash for emergencies and pleasure.

This system requires dedication and practice, but it can be done. Better, you'll avoid using credit cards as a stop gap measure, and instead just use them for what they are: short-term payment tools for the things you can afford.

Got a question for Erica? Send her an email.