Cash Advance - Risks and Benefits
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When you are in a bind, and money is needed to satiate your immediate needs, a cash advance can be a tempting offer. Cash advances give consumers access to quick cash but also do indeed come with strings attached. Is a cash advance truly right for you? We discuss below.
In this article
What is a cash advance?
A cash advance is a type of short-term loan that provides immediate access to funds. In the majority of cases, these loans are most often offered by credit card companies, cash advance direct lenders, or other financial institutions and can be obtained in several ways. These include ATM withdrawals, online applications, or in-person transactions.
Cash advances are intended to help with urgent expenses, such as a medical bill or a necessary home repair, but their accessibility often comes with strings attached. Borrowers face steep interest rates, additional fees, and a lack of flexibility in repayment terms compared to other forms of financing.
- Access up to $750 per pay period
- No interest, mandatory fees, or credit checks
- Over 15 million downloads and counting
Types of cash advances
Cash advances come in various forms, each tailored to different financial needs and circumstances.
Credit card cash advances
This is probably the most common type of cash advance that most people will have used before. It allows you to borrow against your credit limit, typically at a high annual percentage rate (APR). These advances can be accessed at ATMs or through convenience checks provided by the card issuer. Remember that a cash advance through credit cards is still taking on credit card debt, so consumers need to be wary of their credit mix, to avoid taking on too much high-interest debt.
Merchant cash advances
Designed for small businesses, this option allows borrowing against future credit card sales. While easy to obtain, merchant cash advances often have high factor rates and repayment tied to daily sales, which can strain cash flow. A business must be operating with reliable cash flow, as even merchant cash advances will have interest rates above the norm.
Payday loans
These short-term loans are marketed as quick fixes for individuals with limited financial options and sometimes limited documentation. Payday loans are notorious for their high interest rates which can exceed 300% in some cases and short repayment windows, making them one of the riskiest forms of cash advances. It´s best to ask yourself ´Do I really need this payday loan?´ before going ahead and getting a payday loan. In fact, the federal government is getting tougher on payday loans, and their existence in the future is murky.
- Access up to $750 per pay period
- No interest, mandatory fees, or credit checks
- Over 15 million downloads and counting
How does a cash advance work?
Cash advances function as quick-access loans, but they are fundamentally different from other types of financing. Borrowers access funds either through their credit card company, direct lender, or financial institution.
Different methods for obtaining a cash advance
- ATM withdrawals. If you’re using a credit card, you can withdraw cash up to your available credit limit at ATMs. Be prepared to pay an upfront cash advance fee along with immediate interest accrual.
- Direct lenders. Many cash advance direct lenders offer quick online applications, often with instant approval. Funds are typically deposited into your bank account within hours or days.
- Merchant cash advances. Businesses apply for a loan tied to future sales, with repayment automatically deducted from daily credit card sales.
Unlike standard credit card purchases, cash advances begin accruing interest immediately. There’s no grace period, and the rates are often significantly higher than regular purchase rates.
Examples of using a cash advance
To better understand the differences between the main types of cash advances, let’s take a look at three realistic scenarios that some of us might have used before a credit card cash advance, a merchant cash advance, and a payday loan. These examples will take a look at how each type works, the costs involved, and how repayment can vary depending on the circumstances.
Scenario 1: Credit card cash advance
Maria is a 35-year-old marketing professional. Her car breaks down unexpectedly, and the repair costs $800. She doesn’t have enough savings and decides to take a credit card cash advance. Her credit card has a cash advance fee of 5% and an interest rate of 24.99% APR (2.08% monthly).
Breakdown of costs:
Advance Amount | Cash Advance Fee | Monthly Interest (if unpaid) |
|---|---|---|
$800 | 5% x 800 = $40 | $800 x 2.08% = $16.64 |
If Maria repays the full amount, including the cash advance fee, within one month, her total cost is:
- Total repayment: $800 + $40 (fee) + $16.64 (interest) = $856.64
If she delays repayment for three months, her cost increases due to interest compounding:
Total Interest (3 months) | Total Repayment: |
|---|---|
$16.64 × 3 = $49.92 | $800 + $40 (fee) + $49.92 = $889.92 |
Scenario 2: Merchant cash advance
Eli, a small business owner, needs funds to purchase additional inventory for the holiday season as the previous year, he ran out of stock. He decides to take a merchant cash advance of $10,000 against future credit card sales. The lender charges a factor rate of 1.2 and requires daily repayments based on 10% of his credit card sales. Eli estimates $400 in daily credit card sales during the busy season.
Breakdown of costs:
Advance Amount | Factor Rate Cost | Daily Repayment |
|---|---|---|
$10,000 | $10,000 × 1.2 = $12,000 | 10% × $400 = $40 |
If Eli maintains consistent daily credit card sales of $400, he will repay the $12,000 merchant cash advance, including the factor rate, in approximately 300 days (around 10 months), with daily repayments of $40. However, if his sales slow to $300 per day, the repayment amount decreases to $30 per day, extending the repayment period to 400 days (around 13 months).
Scenario 3: Payday loan
Samantha, a part-time retail worker, faces an unexpected $500 medical bill. With no emergency savings, she takes out a payday loan for $500. The loan has a 14-day repayment term with a fee of $15 per $100 borrowed.
Breakdown of Costs:
Advance Amount | Flat Fee | Total Repayment (14 days) |
|---|---|---|
$500 | $15 × 5 ($100 increments) = $75 | $500 + $75 = $575 |
If Samantha is unable to repay the loan on time and rolls it over for another 14 days, she incurs an additional $75 fee.
The chart below compares the costs and repayment timelines for three common types of cash advances: credit card cash advances, merchant cash advances, and payday loans.
- Access up to $750 per pay period
- No interest, mandatory fees, or credit checks
- Over 15 million downloads and counting
Benefits of cash advances
Cash advances are important, they provide a financial lifeline when otherwise one might not exist. No one wants to be 'up the creek without a paddle´regarding a particular set of financial circumstances, and cash advances do offer that lifeline. Some of the benefits of cash-advances are as follows:
Fast access to funds
One of the most appealing features of cash advances is their speed of course. Whether you’re facing an unexpected expense or need to cover a short-term gap in your cash flow, cash advances provide funds almost instantly, making them a go-to choice in emergencies.
No need for collateral
Unlike secured loans, cash advances don’t require borrowers to pledge assets, such as a home or car, as collateral. This makes them accessible to individuals without significant assets or those who want to avoid risking personal property. That being said, unsecured loans will always come with higher interest rates, so there is indeed a tradeoff.
Flexible spending
Cash advances don’t come with spending restrictions, making them suitable for a variety of uses, including paying bills, covering business expenses, or managing personal emergencies.
Risks of cash advances
While cash advances can be helpful in certain situations, they come with significant risks that borrowers must consider carefully.
High-interest rates and fees
Most cash advances carry higher interest rates than regular credit card purchases. Additionally, borrowers often face cash advance fees, which can range from 3% to 5% of the borrowed amount. These costs add up quickly, especially if the advance isn’t repaid promptly.
Negative impact on credit score
Taking out a cash advance increases your credit utilization ratio, a key factor in determining your credit score. High credit utilization can lower your score, especially if you already carry a balance on your credit card. If you are right on the brink with your credit score, it may be a smarter idea to skip the cash advance and see if you can obtain money through other methods.
Short repayment terms
Many cash advances, particularly payday loans, require repayment within weeks, putting additional pressure on borrowers. Failing to meet repayment deadlines can result in late fees, higher balances, and even collection efforts from lenders.
- Access up to $750 per pay period
- No interest, mandatory fees, or credit checks
- Over 15 million downloads and counting
Comparing cash advances to other loan types
Cash advances are not the only option when you need money quickly. Here’s a comparison to help you evaluate whether it’s the right choice for your situation:
Feature | Cash Advance | Personal Loan | Line of Credit |
|---|---|---|---|
Interest Rates | High | Moderate | Lower |
Loan Amount | Small | Medium to Large | Flexible |
Approval Process | Instant or 1-2 Days | 1-5 Days | 1-2 Weeks |
Fees | Higher | Lower | Varies |
When should you consider a cash advance?
The short answer is, only if you need it. cash advances should only be considered under specific and urgent circumstances due to their high costs, fees, and associated risks. These types of loans are purposed only for immediate cash needs, such as medical bills, family emergencies, or other expenses. They can provide a quick solution to financial gaps when no other funds or resources are available, but their convenience comes with high interest rates and potential long-term financial consequences.
If you decide to take out a cash advance, make sure you pay it back as fast as possible! Borrowers should carefully assess their repayment capacity before committing, as delaying repayment can lead to a cycle of debt that is hard to escape. Cash advances should always be a last resort after exploring other options—such as personal loans, credit card balance transfers, or borrowing from an emergency fund.
Alternatives to cash advances
If the risks of a cash advance outweigh the benefits, consider these alternatives:
- Personal loans. Personal loans are often a more affordable alternative to cash advances, as they typically come with lower interest rates and more predictable repayment terms. While they may take a few days for approval and funding, they are well-suited for larger expenses or planned financial needs. Personal loans will also be more flexible with payment options, and have a bit more ´wiggle room´in general than cash advances.
- Credit cards. For smaller purchases, using a credit card directly can be a better choice than taking out a cash advance. This option helps you avoid the cash advance fee and the lack of a grace period. Credit cards are especially helpful when you need to make immediate purchases but have the ability to pay off the balance in full by the next billing cycle.
- Emergency fund. Building and maintaining an emergency fund is one of the most effective ways to avoid relying on costly borrowing options like cash advances or payday loans. An emergency fund provides a financial safety net for unexpected expenses, such as medical bills, car repairs, or job loss. By planning ahead and saving regularly, you can create a buffer that eliminates the need for high-cost, short-term borrowing in times of need.
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FAQs
What happens if I can’t repay my cash advance?
If you don´t pay your balance off on time you will get hit with more fees and a potential downgrading of your credit score. In some cases, you might even be on the hook for a higher interest rate on your existing debt. In a worst-case scenario, it can be sent to collections.
Can I get a cash advance without a credit check?
Yes, in fact, the payday loan option for cash advances will sometimes come with ´no credit or low credit' parameters. These are the types of loans with sky-high interest rates and should be avoided at all costs, unless absolutely necessary.
How does a cash advance affect my credit utilization?
As a rule of thumb, credit utilization should be kept at 30%. Just like any time you take on more debt, any cash advance should be factored into your credit utilization ratio, as this can affect your credit.
The bottom line
If you take out a cash advance, your immediate goal should be devising a plan to pay it back as quickly as possible. Paying back a cash advance quickly is key to keeping costs low and protecting your credit score. Interest starts adding up right away, there’s no grace period, so the quicker you pay it off, the less you’ll owe in extra charges. It’s better to pay the whole balance instead of just the minimum payment, as this keeps the debt from growing bigger over time. This is how people get themselves into debt traps.
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Writer
Benjamin is a writer and entrepreneur who spent 15 years in Asis involved in the real estate and financial services industry. He currently writes about finance, real estate, geopolitics, and short stories involving his cat from Argentina named Tuki. He has written for The Motley Fool, SuperMoney, and other online and offline publications spanning the globe.
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