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How a Cash Advance Works

Adam Uzialko
Adam Uzialko
Freelance Editor

A cash advance provides you with fast cash, but is it worth the high price?

  • A cash advance is based on a credit card or future paycheck, not your credit score.
  • They provide fast, short-term financing at a high interest rate.
  • They are very expensive and can be dangerous if used recklessly.
  • They should be your last resort as a financing option.

If you've ever needed cash quickly, you know how much pressure it can be. Nobody likes having financial obligations they aren't sure how to meet, so many turn to a type of financing known as a cash advance.

A cash advance is a short-term loan that doesn't require an application or a credit check, so it seems like a great option in a pinch. However, cash advances aren't always as helpful as they seem. In many cases, they can even exacerbate an already-difficult financial situation.

How do you know when to consider a cash advance, and when you should leave it alone? This guide will introduce you to the concept of a cash advance, as well as the pros and cons associated with it, so you can make an informed decision as to whether a cash advance is right for you.


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What is a cash advance?

A cash advance is a particular type of short-term loan that an individual can take out of an ATM or bank branch with an eligible credit card (not all credit cards are eligible for cash advances).

"A cash advance is basically where you borrow money from your credit card and pay a pretty exorbitant interest rate upon repayment," said Andrew Schrage, co-founder and CEO of Money Crashers. "It can be also qualified as a payday loan in some instances, which in some ways acts in the same way, although not completely."

Cash advances are an expensive way to borrow money quickly. They typically carry a higher interest rate than normal credit card purchases, often around 25% or higher.

What is a payday loan?

A payday loan is very similar to a cash advance, with one major difference: what you are borrowing against. While cash advances are based on your credit limit, payday loans are based on your future expected income.

"[A payday loan] is a type of cash advance that borrows against your income and expected check," said Chane Steiner, CEO of Crediful. "Again, these have high interest rates and unfavorable terms, but they are approved quickly, without considering your credit score."

Payday loans are the personal equivalent of a type of business funding known as the merchant cash advance.

What is a merchant cash advance?

Merchant cash advances are distinct from personal cash advances and payday loans. While personal cash advances involve the use of a credit card to withdraw cash at a high interest rate, merchant cash advances are instead based on the future revenue of a business. For example, if a lender provides a merchant cash advance of $20,000 to a business, the business will then repay the advance with a percentage of its monthly revenue until it is repaid in full, plus fees.

Merchant cash advances are generally employed by businesses with established cash flow that can't obtain a conventional bank loan. They are among the most expensive business financing options out there, but they still require significant evidence of existing revenue to secure. Personal cash advances simply require an eligible credit card.

What are the pros and cons of a cash advance?

A cash advance is one of the easiest methods of financing to obtain, which explains the exorbitant cost. There is very little involved in the process, Schrage said.

"The only real requirement to receive a cash advance is that the credit card with which you are requesting one offers cash advances," he said. "There's typically no credit check required."

This makes cash advances an extremely flexible source of financing for individuals. Of course, that flexibility comes at a steep cost.

"Your issuer will charge a cash advance fee, which is typically 3% to 5% of the transaction with a minimum of $10," said Kevin Chen, a credit cards writer at Finder.com. "Even more dangerous, perhaps, is the steep interest rate you'll pay on your cash advance. It's very common for cash advance APRs to be above 25%.

"In addition, cash advances don't come with a grace period – that is, the window after each billing cycle during which you can pay off your balance in full to avoid interest. Each cash advance will start accruing interest immediately."

Finally, just because you make a hefty credit card payment doesn't mean you'll be paying off your cash advance. Any lower-interest credit card balance is paid off before a cash advance, which means a cash advance could still accrue interest at an excessive rate even after a significant credit card payment. If you carried a balance of $500 on your credit card, for example, and then took a cash advance of $100, you would pay off the $500 before any payments were applied to the higher-interest cash advance of $100.

The resounding advice from the experts we spoke with? Don't take a cash advance unless it is your only option.

"Your best bet is to avoid needing a cash advance at all costs," Schrage said. "Instead, you could borrow money from a family member or friend [or] take out a personal loan …" [Read related article: Loans You Can Get With Bad Credit]

If things are desperate, Schrage even suggested withdrawing more money from your checking account than your balance reflects.

"This obviously isn't ideal, because you'll pay a fee, but it is usually less costly in the long run since you would not be paying interest," he said.

Is a cash advance bad for your credit?

Cash advances don't require a credit check, so they do not necessarily impact your credit score. However, a big factor in your overall score is your credit utilization rate. Your credit utilization rate compares your total credit limit across all credit cards to your total outstanding credit balance. Experts recommend maintaining a credit utilization of no more than 30%. That means, at any given time, 70% of your total credit limit should be available. Because cash advances use a portion of your credit limit, excessive withdrawals can ultimately drag down your credit score, especially as interest accrues on a cash advance.

"The dangers of a cash advance usually involve revolving utilization debt," Steiner said. "You borrow against your check or your credit card, and because of the high interest rates, it takes a significant amount to pay this back, which often requires you to take out another advance. This is a slippery slope in terms of debt."

What are the alternatives to cash advances?

Given that cash advances carry a major risk, they should be used as a last resort. That said, according to Take Charge America, the following is a list of cash advance alternatives:

  • Personal loans. One way to get your hands on some quick cash is by taking out a personal loan. If you have the credit, you may be able to take out a personal loan from an array of banks or other financial institutions.

  • Emergency fund. If you have an emergency fund that you are saving for a rainy day, you may have to just realize that the rain has come. If you find yourself taking out cash advances, you are much better off dipping into your fund than you will be if you take out a cash advance.

  • Sell assets. Additionally, if you have things of value that you can sell for cash, this is another alternative to taking out cash advances. For instance, you can sell things such as jewelry, clothing, etc., online to earn the money you need. If you have multiple methods of transportation, you can sell a car, bike, etc.

  • Phone a friend or family. No one likes to borrow money, but if you are taking cash advances, you may just want to call a friend or family member to see if they will loan you the money. Moreover, if you are not able or unwilling to get the total amount from one person, you could simply ask everyone to borrow a small amount of money until you reach your goal.

  • Use your credit card to pay for purchases. If you need the money for something that you can charge, you will be better off just charging it to your credit card directly.

  • Peer-to-peer lending. According to Investopedia, peer-to-peer lending is a type of lending that enables people to borrow money directly from their peers rather than going through a financial institution.

Use cash advances as a last resort.

Cash advances are extremely expensive and potentially dangerous entryways into a vicious cycle of high-interest debt. The best option is to avoid a cash advance altogether. However, if you find yourself in an emergency situation with no other form of fast financing available, a cash advance could help you out of a jam. Even then, it is best to only accept a cash advance if you know you will be able to pay it off quickly, without succumbing to the never-ending trap of taking advance after advance to cover your debts.

Ultimately, especially for the aspiring business owner, debt should be a tool, not a necessity. If you can't survive without high-interest financing like a cash advance, it might be time to question the viability of your business model. In some cases, it could be better to close your doors, reassess and relaunch your business in a new way than to take on a heavy burden of debt.

Image Credit: Dutko / Getty Images
Adam Uzialko
Adam Uzialko
business.com Staff
Adam Uzialko is a writer and editor at business.com and Business News Daily. He has 7 years of professional experience with a focus on small businesses and startups. He has covered topics including digital marketing, SEO, business communications, and public policy. He has also written about emerging technologies and their intersection with business, including artificial intelligence, the Internet of Things, and blockchain.