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How a Cash Advance Works

By Adam Uzialko,
business.com writer
|
Mar 06, 2020
Image Credit: Dutko / Getty Images
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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.
  • Cash advances provide fast, short-term financing at a high interest rate.
  • Cash advances are very expensive and can be dangerous if used recklessly.
  • A cash advance 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."

Cash advances are a financing option of 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.

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Adam Uzialko
Adam Uzialko
See Adam Uzialko's Profile
Freelance editor at business.com. Responsible for managing freelance budget, editing freelance and contributor content, and drafting original articles. Also creates product and service reviews to assist business.com readers in buying decisions for their businesses. VP and co-founder of CannaContent, a digital marketing company dedicated to the cannabis, hemp, and CBD industries. Focused specifically on the content marketing arm of the company, creating blogs, press releases, and website copy for clients spanning the entire supply chain. Avid fan and indispensable ally of the feline species. Music lover, middling guitarist, and unprompted vocalist. Miniature painter who loves sci-fi and fantasy. Armchair political philosopher with a tendency to read old books written by men with unusually large beards. Ask me about all things writing!
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