Cash advance: definition, types and impact on creditworthiness (2023)

What is a cash advance?

A cash advance is ashort term creditfrom a bank or alternative lender. The term also refers to a service provided by many credit card issuers that allows cardholders to withdraw a specified amount of cash in exchange for available credit. Cash loans often come with high interest rates and fees, but they are attractive to borrowers because they are also characterized by fast approval and quick funding.

Types of cash advances

There are many types of cash advances, but the common denominator is high interest and fees.

Credit card cash advances

The most common type of cash advance is borrowing a line of credit through a credit card. Money can be withdrawn from an ATM or, depending on the card company, from a check deposited or withdrawn from the bank. Credit card cash advances usually carry higher interest rates than the rates on regular purchases. Moreover, interest starts flowing immediately; there is notGrace period.

These cash advances usually also include a fee, a fixed fee, or a percentage of the advance. Also, if you use an ATM to access cash, there will often be a small usage fee.

With separate interest rates, credit card cash advances have a separate balance from credit purchases, but the monthly payment can be applied to both balances. However, if you only pay the minimum amount owed, your card issuer is authorized by federal law to apply it to the balance with the lowest interest rate. Because it's always the purchase rate, the cash advance balance can sit and collect interest at this high rate for months.

Any withdrawals above the minimum should count towards your maximum interest, so it's wise to pay more than the minimum if possible.

In most cases, credit card cash advances do not qualify for low interest or no interest introductory offers. The positive side is that they can be obtained quickly and easily.

Merchant Cash Advances

Merchant Cash Advancesrefer to loans received by businesses or traders from banks or alternative lenders.Businesses that don't have perfect credit typically use cash advances to finance their business, and in some cases, these advances are paid off with future credit card revenue or a portion of the revenue the business receives from sales on its account. Instead of using a company's credit score, alternative lenders often look at its credit scoresolvencyby checking various details, including the amount of money the seller receives through online accounts such as PayPal.

payday loans

In the case of a consumer loan, the term "cash advance" can also be mentioned.payday loans. Issued by special creditors,loans can start from $1,000 to $50,000, but they come with fees (usually around $15 per $100 borrowed) and interest rates in excess of 100%.Instead of considering the borrower's creditworthiness, the lender determines the loan amount based on local state laws and the size of the applicant's salary. If the loan is approved, the lender transfers the money to the borrower; if the transaction is online, the lender makes an electronic payment to the borrower's checking or savings account.

The loans are extremely short-term - the borrower must repay them in the next quick loan, unless the borrower intends to extend the loan, in which case additional interest is charged. Unfortunately, many people do: according to a study conducted by the company in 2014, more than 80% of all quick loans were approved within 30 days of the previous loan.Consumer Financial Protection Bureau (CFPB).

Payday loans are legal in only 26 states, and of those, 16 require lenders to offer extended payment plans to mitigate excessive switching fees. However, many payday lenders don't advertise these repayment plans, hoping borrowers will overdo it.

The process can be faster, though more complicated, than securing a cash advance with a credit card. To get a payday loan, fill out a post-dated check made out to the lender for the amount you plan to borrow, including fees. The lender spends the borrowed amount immediately, but waits until the payday to cash the check. Some electronically minded lenders now require borrowers to sign an agreement to automatically pay off their bank accounts. Lenders often ask for your ID and proof of income when applying.

Some employers offer payday loans or payday advances to their employees. Terms vary, but often no fees or interest are charged.

Do Cash Advances Affect Your Credit Score?

Taking out a cash advance does not directly affect your credit or creditworthiness, but it can affect you indirectly in a number of ways.

First, if you take out a credit card advance, your debt balance will increase, which will increase yoursloan utilization rate, measure whichCredit ratingmodels use to calculate your score. For example, if you owe $500 on a card with a $1,500 limit, your credit utilization is 30%. However, if you make a $300 cash advance on this card, your balance will increase to $800, resulting in a credit utilization of over 53%.High utilization rates are an excellent indicator of credit risk.

As mentioned earlier, a cash advance usually has a high interest rate. If it affects your ability to make your monthly payments promptly, it can also affect your credit score. And if the advance exceeds your card's credit limit, your credit score may be lowered. Even after paying off the balance, your credit report will show the highest balance, and other potential creditors will see that you went over the limit at some point, which could jeopardize your ability to get new credit.

Advantages and disadvantages of a cash advance

A credit card cash advance can be a reasonable option for someone who needs cash urgently and has limited means to get it, especially when that person has a clear and reasonable plan to repay the money in the short term. This is, for example, a better option than a loan against an employment contract or a quick loancar loan, due to the exorbitant triple-digit interest rates typically associated with these loans and the greater payment flexibility associated with credit card debt.

But cash advances would be a bad idea under the following conditions:

• Just before declaring bankruptcy: New credit card debt doesn't magically disappearbankruptcy. Your creditors and the judge will check your debts, including dates and types. If you know or have a strong tendency to file for bankruptcy soon, using any credit card can be considered fraud. It is very likely that the card issuer will dispute the cash advance made just prior to the application and this account may be excluded from discharged debts in bankruptcy.
• To pay your credit card bill: A cash advance is a very expensive way to pay bills and you cannot ignore the risk of taking on revolving debt. The possibility of paying multiple amounts of the initial advance (interest) is very real. In addition, in addition to higher interest, there are additional fees that are not subject to everyday credit card purchases.
• Buy something you can't afford: Borrowing to satisfy desires is dangerous not only financially;it is emotionally damaging. A person who seeks the instant gratification and temporary emotional uplift of a large purchase will eventually experience sadness (and possibly depression, anxiety, stress, and other debilitating emotions) when faced with debt—the more compulsive the purchase, the more pronounced the debt will be. repentance.

the final result

Cash advances are not a problem if they are used infrequently, but they are short-term solutions that cover emergencies at best. If they become a habit or if you regularly need a cash advance to survive, then drastic changes in your budget and expenses are indicated.