When you are in need of cash that you don't have, you may not always stop to think through the best means of acquiring it. If your need is great, you may take a cash advance on a credit card, for example, without considering the cash advance interest and how you will repay it. Here's a look at how interest on a cash advance works and how to minimize it.
- Credit card companies treat cash advances differently from regular credit card purchases.
- Credit card companies charge fees on cash advances.
- Using a credit card for cash comes with a higher interest rate than using a card for purchases.
- Consumers should take the time to read the terms of a cash advance before taking one out.
What Is a Cash Advance Using a Credit Card?
A cash advance is a way of obtaining immediate funds through your credit card. It is not unlike a payday loan, only the funds are being advanced not against your paycheck but against your card’s line of credit. In one sense, a cash advance acts like any other purchase being made through your credit card, but instead of buying goods or services, you are "buying" cash.
What many people don't understand about cash advances is that your credit card handles them differently from the way it handles credit on purchases. Taking a cash advance is not the same thing as using your card for products or services.
Among other things, the cash advance interest rate may be higher and there may be a transaction fee. A cash advance may still make sense compared to other ways of getting a quick loan, such as a payday loan, which must be paid back, usually by your next paycheck.
How to Get a Cash Advance from a Credit Card
Cardholders obtain a cash advance by visiting an ATM, bank, or other financial institution, or by requesting a check from the credit card company. In fact, some card issuers periodically send checks in the mail as a way to entice consumers into getting a cash advance from their cards. Check your credit card terms to find out what your cash advance limit is and how much credit is available to you for a cash advance.
If the card company invites you to take a cash advance, what could be wrong? You probably already know the overall answer to that question. But the devil is in the details, and you need to fully understand what you're getting into before you exercise your cash advance option.
Credit Card Cash Advances vs. Regular Purchases
Credit card companies like cash advances in part because they treat the interest on them differently from interest on card purchases. There are different terms for credit card purchases versus cash advances. For one, the interest rate is often higher on a cash advance by several percentage points,
Also, any special interest-rate promotions on the card—such as no interest until a certain date—may not be applicable on cash advances, meaning you could get dinged unexpectedly.
Unlike regular purchases, there is no grace period on cash advances. Interest starts accruing from the date of the transaction.
Besides charging a higher-than-normal interest rate, credit card companies also automatically charge a transaction fee on the advanced sum—for example, 3% to 5%, or a flat rate of, say, $10, whichever is greater. What’s more, cash advances do not typically qualify for rewards, cash-back programs, or any other credit card benefits. Your cash advance line is almost always considered to be separate from the rest of your credit balance.
You can learn the details for your particular card from its website or the documents you were given when you signed on—if it's a special offer, that's the part you should check.
How Does Credit Card Interest Work with a Cash Advance?
As noted above, the interest charges on a cash advance are different from those on a purchase. Not only is the rate generally higher for a cash advance, but there is no grace period, which means that interest starts to accrue from the date of the transaction. And you will pay interest on your cash advance even if you pay it off in full and had a zero balance for that billing cycle.
You also have the option of paying off the cash advance over time, just as you can with a purchase, as long as you make minimum monthly payments.
How your payments are applied
Thanks to the Credit Card Act of 2009, credit card payments above the minimum payment amount are made to higher-interest purchases first. This was a major change to how credit card companies can apply payments (previously companies could apply payments to lower-interest purchases).
Let's say you have a $5,000 balance on a card with a special annual percentage rate (APR) of 10% that you plan to take 15 months to pay off, and while you are doing so you take out a $500 cash advance that generates 22.5% in interest. Depending on how large a payment you make, it may be split between your balances.
If you only make the required minimum monthly payment, in all likelihood it will be applied to the $5,000 balance—that is at the credit card issuer's discretion. Since you are already carrying a balance on your credit card, you will have to pay more than the minimum to pay off the cash advance more quickly.
Better to Simply Use the Credit Card Itself
Instead of taking a cash advance, try to use the credit card itself. If there is something that has to be paid for and you absolutely cannot use a credit card to do so, take as small a cash advance as possible to reduce interest charges, and be sure to pay off your balance as quickly as you can.
The Bottom Line
Like balance transfers, cash advances can be a good resource in certain circumstances. However, it is important for consumers to understand the terms of the agreement, including interest rates and one-time fees, before proceeding with these transactions. Your high-interest cash advance loan could stick around for a very long time if you do not manage it appropriately.