What is a Cash Advance?

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Definition:

A cash advance is a short-term loan from a bank, credit card company, payday lender, or other type of lender, typically with a high-interest rate or hefty fees.

🤔 Understanding cash advances

A cash advance is a type of short-term loan in cash. Interest rates and fees on cash advances are generally quite high, but they have a fast approval process, which makes them attractive for borrowers who need money in a pinch. Cash advances are typically provided by credit card companies and can be taken out at ATMs — You simply use your credit card to “buy” cash at the ATM instead of buying a product or service. However, you can also take out cash advances from payday lenders, banks, and other alternative lenders.

Example

Imagine Lisa’s car breaks down, and she needs to pay $500 to fix it. Lisa doesn’t have enough money on hand or in her bank account to pay for the repair, so she uses her credit card to take out a $500 cash advance at the ATM. Her credit card issuer charges an upfront fee of 3%, which comes to $15 ($500 0.03), and an interest rate of 23% for cash advances. Lisa pays back the loan 30 days later and accrues $9.45 in non-compounded interest in that time (($500 (0.23/365)) * 30), bringing the total amount she paid for the cash advance, in interest, fees, and principal, to $524.45.

Takeaway

A cash advance is kind of like a break-glass-in-case-of-emergency fire extinguisher box...

When there’s a fire — like when you have a financial emergency — you may need to move quickly and break things to douse the flames. High interest rates and fees are the glass — the short-term cash is the fire extinguisher. You won’t want to deal with the mess and expense unless you have a real emergency; but if you need it, you’ll be glad to have access.

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What is a cash advance?

A cash advance is a short-term loan that typically provides cash to borrowers in a pinch. Compared to other types of loans, cash advances are very expensive and typically have high interest rates and fees. Because of this, they are often viewed as a last-resort loan for when you’re out of other options.

One of the most common ways to take out a cash advance is by using a credit card account. There are a few ways to do so: You can simply use a credit card instead of a debit card to withdraw cash at an ATM; you can withdraw the cash in-person from a teller with a convenience check (a check that withdraws cash from your credit card credit line), or you can initiate a direct transfer.

However, unlike regular credit card purchases, most cash advances don’t have a grace period, i.e., a period of time before interest starts accruing on the balance. This means interest starts accruing right away. Plus, the interest rates are significantly higher than for normal purchases — And most credit cards also charge an initial cash advance fee as well. The combination of the lack of a grace period, fees, and high interest rates makes cash advances a very expensive type of loan.

Cash advances also aren’t restricted to credit cards. Payday lenders offer cash advances as well — But these have extremely high interest rates, sometimes as high as 480% APR. (Personal loans, on the other hand, are offered by traditional lenders, and often provide cash advances with even lower interest rates than credit card cash advances.)

There is also something called a debit card cash advance, which is when a bank allows a withdrawal by a non-customer. However, this money is just coming from your own bank account, so it’s not a loan like other cash advances. The bank where you’re not a customer may charge a fee, either as a dollar amount or as a percentage of the amount you’re withdrawing — but this is not likely to be anywhere near as expensive as a proper cash advance.

How does a cash advance work?

The easiest way to get a cash advance is to simply use your credit card at an ATM. When you do this, you’ll have the option of taking out a loan against your credit card’s credit line, right from the ATM. Credit cards typically have cash advance limits that are far below the credit card’s overall credit limit. So, if you have a credit limit of $10,000, for example, you may only be able to take out a $1,000 cash advance.

When you take out your cash advance, your credit card issuer may charge some transaction fees. From there, interest will start accruing immediately (there’s no grace period) and may compound, too. So you’ll typically want to pay off the loan as quickly as possible. But this can be tricky: If you simply make the minimum payment on your credit card, that money may not go toward your cash advance balance. To ensure that you’re paying off your cash advance, you’ll need to make more than the minimum monthly payment — the 2009 CARD Act requires creditors to apply payments greater than the minimum to the highest-interest-rate balance.

However, credit cards aren’t the only way to take out a cash advance. Borrowers can also take out payday loans from payday lenders — though, typically, at a much higher interest rate. These types of loans get their name from the fact that borrowers are supposed to pay back the loan upon receipt of their next paycheck. To take out a payday loan, a borrower just needs to provide proof of income and their checking account information. Personal loans from other lenders are also an option.

What are the types of cash advances?

There are four main types of cash advances:

  • Credit card cash advance: In this type of loan, you borrow against your credit card’s line of credit. This is perhaps the most convenient way to get a cash advance, as you need only go to an ATM.
  • Payday loans: This type of cash advance gets its name from the fact that borrowers were traditionally expected to pay back the loan when they got their next paycheck, i.e., on their next payday. These types of loans can be taken out online or in-person at a store. They are not legal in all states.
  • Personal installment loans (personal loans): Personal loans are cash advances, sometimes from traditional lenders like Citibank and Wells Fargo, that often have lower interest rates and may be used for larger purchases thanks to their higher maximums.
  • Merchant cash advance (MCA): This is not technically a loan. Instead, a merchant cash advance provides business owners and merchants a lump sum payment, which is paid off by taking a percentage of future credit card earnings, not through monthly installments.

How do you get a cash advance?

There are several ways to get a cash advance.

  • Use your credit card to withdraw cash at an ATM
  • Use your credit card to withdraw cash at a bank teller window
  • Cash a convenience check
  • Call your bank or go online to get a direct transfer from your credit card into your bank account
  • Take out a personal loan
  • Take out a payday loan
  • Take out a merchant cash advance (for business owners and merchants)

How do you pay off a cash advance immediately?

If you take out a payday loan or personal loan, you can pay it off just like you would any other loan.

However, if you take out a cash advance with your credit card, the balance is typically separate from the rest of your credit card purchases — If you simply make the monthly minimum payment, you may not even make a dent in your cash advance. To pay it off immediately, you’ll need to take extra steps.

According to the 2009 CARD Act, any credit card payments in excess of the monthly minimum must go towards the highest-interest balance. So, you’ll need to pay the monthly minimum plus the cash advance balance and any interest that’s accrued on it to ensure you pay it off.

What is the cash advance limit?

The cash advance limit is the maximum amount you can take out as a cash advance on a credit card. Typically, this is significantly less than your credit limit. So, if you have a credit limit of $10,000, you may only be able to take out $1,000 as a cash advance, for example.

Why are cash advances expensive?

A cash advance is an unsecured loan, which means that there is no collateral to back up the loan. When you take out a home equity loan, for example, you use your house as collateral — If you default on the loan (don’t pay it back), the lender can take your house.

But cash advances don’t have any collateral, and people who take out cash advances may be doing very poorly financially, so lenders typically charge higher interest rates to cover the increased risk.

Think of it like this: How comfortable would you feel making a loan to someone who says they need cash because they’re broke and can’t cover their expenses? It probably wouldn’t inspire very much confidence.

Because of this, lenders charge very high fees and interest rates, both to discourage people from taking cash advances that they can’t pay back and to protect themselves by immediately taking back some of the loan in the form of interest (hence the no grace period). If fees weren’t so high, borrowers might start viewing cash advances as free money and borrowing more than they can pay back.

Although giving more high interest loans might appear to be good for lenders, they only make money off interest if the borrower actually pays back the loan. So, lenders need to walk a fine line between encouraging people who can afford high-interest loans to take them and discouraging people who won’t be able to pay them back.

Do cash advances hurt your credit score?

Taking out a cash advance with your credit card usually does not hurt your credit score — assuming you can pay it back on time, keep your outstanding balances within recommended bounds (30% credit utilization), and don’t engage in any other behaviors that could lower your credit score.

However, if you take out a personal loan or other cash advance from a lender that does a ‘hard pull’ on your credit score, this may have a negative impact.

What are the pros and cons of cash advances?

The advantages and disadvantages of cash advances are pretty clear cut. On the plus side, cash advances provide borrowers with cash, fast. This helps borrowers who need money in a pinch to pay off an emergency expense.

On the downside, cash advances are expensive loans, which means you’ll be paying a lot more than the principal of the loan. If you can’t pay off the loan quickly, you can get into a bad cycle of debt, in which you keep paying off the interest without ever touching the principal.

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