What is 'Cash Advance'
A cash advance is a short-term loan from a bank or alternative lender. The term also refers to a service provided by many credit card issuers allowing cardholders to withdraw a certain amount of cash. Cash advances generally feature steep interest rates and/or fees, but they are attractive to borrowers because they also feature fast approval and quick funding.
BREAKING DOWN 'Cash Advance'
Types of Cash Advances
There are a variety of cash advances, but the common denominators among all of them are the stiff interest rates and fees.
Credit Card Cash Advances
The most popular type of cash advance is borrowing on a line of credit through a credit card. The money can be withdrawn at an ATM or, depending on the credit card company, from a check that is deposited or cashed at a bank. Credit card cash advances typically carry a high interest rate, even higher than the rate on regular purchases: you’ll pay an average of 23.53% – about 8.54% higher than the average APR for purchases. What's more, the interest begins to accrue immediately; there is no grace period.
They usually include a fee as well, either a flat rate or percentage of the advanced amount. Additionally, if you use an ATM to access the cash, you often are charged a small usage fee.
Along with separate interest rates, credit card cash advances carry a separate balance from credit purchases, but the monthly payment can be applied to both balances. However, if you are only paying the minimum amount due, the card issuer is allowed by federal law to apply it to the balance with the lower interest rate. Since that is invariably the rate for purchases, the cash advance balance can sit and accrue interest at that high rate for months.
In most cases, credit card cash advances do not quality for no- or low-interest rate introductory offers. On the plus side, they are quick and easy to obtain.
Merchant Cash Advances
Merchant cash advances refer to loans received by companies or merchants from banks or alternative lenders. Typically, businesses with less-than-perfect credit use cash advances to finance their activities, and in some cases, these advances are paid for with future credit card receipts or with a portion of the funds the merchant receives from sales in his online account. Rather than using a business' credit score, alternative lenders often survey its creditworthiness by looking at multiple data points, including how much money the merchant receives through online accounts such as PayPal.
In consumer lending, the phrase "cash advance" can also refer to payday loans. Issued by special payday lenders, they can range anywhere from $50 to $1,000, but they come with fees (around $15 per $100 borrowed) and interest rates exceeding 100%. Rather than taking into account the borrower's credit score, the lender determines the amount of the loan based on local state regulations and the size of the applicant's paycheck. If the loan is approved, the lender hands the borrower cash; if the transaction takes place online, the lender makes an electronic deposit to the borrower's checking or savings account.
The loans are extremely short-term – required to be paid back on the borrower's next payday, unless he or she wishes to extend the loan, and in that case additional interest is charged. Unfortunately, many do: 80% of all payday loans are rolled over within 30 days of the previous loan, according to a study by the Consumer Financial Protection Bureau (CFPB).
The process can be quick, if more complex, than securing a credit card cash advance. To get a payday loan, you write a postdated check made out to the payday lender for the amount you plan to borrow, including the fees. The lender in turn immediately issues the borrowed amount, but waits to cash your check until the payday comes. Nowadays, some electronically minded lenders have borrowers sign an agreement for automatic repayment from their bank accounts. Lenders usually ask that you provide personal identification and proof of income when you apply.
Some employers offer payday loans or advances on paychecks as a service to their employees. Terms vary, but often no fees or interest are charged.
Direct Deposit Advances
Another form of cash advance is a direct deposit advance. With this lending tool, banks advance an amount based on a customer's direct deposits. Then, when the deposit is actually made, the bank recoups the loan and the associated fees. In most cases, the repayment for the cash advance is taken out of the account before any other checks, charges or automatic payments are allowed to post. In 2014, after receiving numerous complaints about the fees related to their cash advances, many major banks discontinued this practice.
Do Cash Advances Hurt Your Credit Score?
Taking out a cash advance has no direct impact on your credit or credit score, but it can affect it indirectly in various ways.
First, if you take the advance using a credit card, it will raise your outstanding balance, which will raise your credit utilization ratio, a measure that credit scoring models use to calculate your score. For example, if you owe $500 on a $1,500 limit card, then your credit utilization ratio is only 30%. However, if you take out a $300 cash advance on that card, then the balance will jump to $800, resulting in a credit utilization of over 53%. High utilization rates are a big indicator of credit risk, and your credit score becomes adversely impacted as your ratio exceeds 40% (see What is a good credit utilization ratio?).
As mentioned earlier, the cash advance usually has a high interest rate. If this affects your ability to pay the monthly charges promptly, that could affect your credit score. And if the cash advance puts you over the card's credit limit, that can lower your credit score. Even after the balance is paid down, your credit report will show the highest balance reported, and other potential lenders will see that you were over the limit at one point, which could hurt your ability to get new credit.
Cash Advance Pros and Cons
A credit card cash advance could be a reasonable option for someone who has an emergency need for money and limited resources for getting it – especially when that person has a clear and reasonable plan for paying back the money in a short amount of 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 those loans typically carry and the greater payoff flexibility that comes with credit card debt.
But cash advances would be a bad idea under these conditions:
1. You're about to file for bankruptcy. New credit card debt does not magically disappear in a bankruptcy. Your creditors and a judge will examine your debts, including the dates and types. Once you know or have a strong inclination that you'll soon file for bankruptcy, credit card use of any kind may be considered fraudulent. A cash advance immediately prior to filing is very likely to be challenged by the card issuer and that account may be excluded from the debts that are forgiven in a bankruptcy. For more, see When To Declare Bankruptcy.
2. 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 potential to pay many times the amount of the original advance (in interest charges) is very real. Furthermore, in addition to the higher interest rate, there are those additional fees that everyday credit card purchases are not subject to.
3. To buy something you want but can't afford. Going into debt for desires is not just financially dangerous, it's emotionally detrimental. A person who thrives on immediate gratification and the temporary emotional lift of a big purchase will eventually feel regret (and possibly depression, anxiety, stress and other debilitating emotions) when faced with the debt. The more compulsive the purchase, the more pronounced the regret. See 5 Ways To Control Emotional Spending.
The Bottom Line
Used once or twice a year, cash advances aren't alarming. But they are at best short-term solutions to meet emergencies. If they are becoming a habit, if you find you regularly need a cash advance to make ends meet, then drastic budgeting and spending changes are in order.