What is a cash advance?
A cash advance is a short-term loan from a bank or other lender. The term also refers to a service provided by many credit card issuers that allows cardholders to withdraw a certain amount of money. Cash advances usually come with high interest rates and fees, but they are attractive to borrowers because they also offer quick approval and funding.
Key points to remember
- A cash advance is a type of short-term loan, often issued by a credit card company, and usually involving high interest and fees.
- Other types of cash advances include merchant cash advances, which are alternative loans for businesses, and payday loans, which have sky-high rates and are banned in many states.
- A credit card cash advance will not directly hurt your credit rating, but it will indirectly hurt it by increasing your outstanding balance and your credit utilization rate, which is a factor in credit scores.
Types of cash advances
There are a variety of cash advances, but the common denominators among them are high interest rates and fees.
Cash advances by credit card
The most popular type of cash advance is to borrow against a line of credit using a credit card. Money can be withdrawn from an ATM or, depending on the credit card company, from a check deposited or cashed in a bank. Credit card cash advances typically carry a high interest rate, even higher than the rate for regular purchases – you’ll pay an average of 24% – approximately 9% higher than the average APR of purchases. In addition, interest begins to accrue immediately; there is no grace period.
These cash advances usually include a fee, either a flat rate or a percentage of the amount advanced. Also, if you use an ATM to access cash, you often incur a small usage fee.
In addition to separate interest rates, credit card cash advances have a separate balance from credit purchases, but the monthly payment can be applied to both balances. However, if you only pay the minimum amount owed, the card issuer is permitted by federal law to apply it to the balance with the lowest interest rate. Since this is invariably the rate of purchases, the cash advance balance can sit and accumulate interest at this high rate for months on end.
In most cases, credit card cash advances do not qualify for low or zero interest introductory offers. On the plus side, they’re quick and easy to get.
Merchant cash advances
Merchant cash advances refer to loans received by businesses or merchants from banks or alternative lenders. Typically, businesses with less than perfect credit use cash advances to finance their operations and in some cases these advances are paid with future credit card receipts or with a portion of the funds the business receives sales on its online account. Rather than using a company’s credit score, alternative lenders often assess its creditworthiness by looking at several data points, including the amount the merchant receives through online accounts such as PayPal.
In consumer credit, the expression “cash advance” can also refer to payday loans. Loans from special lenders can range from $ 50 to $ 1,000, but come with fees (about $ 15 per $ 100 borrowed – or more in some cases) and interest rates exceeding 100%. Rather than taking the borrower’s credit rating into account, the lender determines the loan amount based on local state regulations and the amount of the applicant’s paycheck. If the loan is approved, the lender returns money to the borrower; if the transaction takes place online, the lender makes an electronic deposit to the borrower’s checking or savings account.
Loans are very short term – they have to be repaid on the borrower’s next pay day unless the borrower wishes to extend the loan, in which case additional interest is charged. Unfortunately, many do: More than 80% of all payday loans are renewed within 30 days of the previous loan, according to a 2016 Consumer Financial Protection Bureau (CFPB) study.
The process can be quick, although more complex, than getting a cash advance with a credit card. To get a payday loan, you write a post-dated check payable to the lender for the amount you plan to borrow, including fees. The lender immediately issues the borrowed amount, but waits to cash your check until payday arrives. Some electronically minded lenders are now asking borrowers to sign an automatic repayment agreement from their bank accounts. Lenders usually ask you to provide identification and proof of income when you apply.
Some employers offer payday loans or payday advances as a service to their employees. Terms vary, but often no fees or interest are charged.
A cash advance can be useful for someone who needs cash quickly and has a solid plan to pay it off quickly. But cash advances can be disastrous if the borrower is on the verge of bankruptcy, has to pay off a credit card or other interest-bearing bills, or just wants the money to buy. more products.
Do cash advances hurt your credit score?
Taking out a cash advance does not directly impact your credit or credit score, but it can indirectly affect it in a number of ways.
First, if you take the advance using a credit card, it will increase your outstanding balance, which will increase your credit utilization rate, a measure that credit scoring models use to calculate your score. . If you owe $ 500 on a $ 1,500 limit card, for example, your credit usage rate is 30%. However, if you take a $ 300 cash advance on this card, the balance will drop to $ 800, which will result in over 53% credit usage. High utilization rates are an important indicator of credit risk; when your ratio exceeds 40%, it can have a negative impact on your credit score.
As stated earlier, a cash advance usually has a high interest rate. If it affects your ability to pay monthly fees quickly, it could also affect your credit score. And if the cash advance causes you to exceed the credit limit on the card, your credit score may be shaken. Even after the balance is paid off, your credit report will show the highest reported balance, and other potential lenders will see that you have exceeded the limit at some point, which could affect your ability to obtain new credit.
Advantages and disadvantages of cash advances
A credit card cash advance might be a reasonable option for someone who is in dire need of the money and has limited resources to get it, especially when that person has a clear and reasonable plan for paying the money back. a short time. It is, for example, a better option than a payday loan or a car title loan, due to the exorbitant triple-digit interest rates that these loans typically carry and the greater repayment flexibility that comes with it. credit card debt.
But cash advances would be a bad idea under these conditions:
- Just before declaring bankruptcy – New credit card debt does not magically disappear in bankruptcy. Your creditors and a judge will review your debts, including dates and types. Once you know or have a strong tendency to file for bankruptcy, using any credit card can be considered fraudulent. A cash advance immediately before deposit is very likely to be challenged by the card issuer, and this account may be excluded from canceled debts in bankruptcy.
- To pay a credit card bill – A cash advance is a very expensive way to pay bills, and the risk of falling into revolving debt cannot be ignored. The possibility of paying several times the amount of the initial advance (in interest charges) is very real. Also, in addition to the higher interest rate, there are additional fees that daily credit card purchases are not subject to.
- To buy something you can’t afford – Getting into debt to satisfy a desire is not only financially dangerous; it is emotionally damaging. A person who thrives on the immediate gratification and temporary emotional uplift of a big purchase will eventually experience regret (and perhaps depression, anxiety, stress, and other debilitating emotions) about the debt – the more compulsive the purchase, the greater the regret.
The bottom line
Cash advances are not alarming when used infrequently, but they are short-term solutions to emergencies at best. If they become a habit or if you find that you regularly need a cash advance to make ends meet, then drastic budget and spending changes are in order.