2 min read
A cash advance is a type of short-term loan, and is also often used to describe a service provided by credit card issuers, via which card-holders can withdraw a specific cash amount. Cash advances provide extremely quick access to funds, but at the cost of high interest rates and fees.
Different types of cash advance
The details of the cash advance vary depending on the specific lender, but they all tend to have high interest rates in common.
Credit card cash advances
This tends to be the most popular form of cash advance, and generally takes the form of simply withdrawing the money from an ATM or, in some cases, depositing or cashing a cheque. The interest rate charged by the credit card companies for cash advances is generally higher than that applied to purchases, and begins to apply as soon as the money has been borrowed.
There is also usually a fee for a credit card cash advance, in the form of a percentage of the full amount or a flat rate.
Merchant cash advances
Merchant cash advances are usually loans given to companies or merchants by banks or other lenders. Businesses with a fairly poor credit rating are more likely to make use of merchant cash advances, and they are often paid on the basis of future credit card receipts or sales from an online account. Rather than running a standard credit check, the lender may look at data points such as the amount of money the merchant receives through online methods like PayPal.
Payday loans are a type of cash advance loan offered to consumers. They are made available to borrowers with poor credit ratings and can be accessed quickly, but the caveat is that they come with extremely high interest rates and fees. They frequently come with a representative APR of more than 1,000%, and although they are designed to be paid back very quickly – usually within a month – the combination of high interest rates and fees often results in the lender paying back twice as much as they borrowed.
How do cash advances affect credit ratings?
Although there is no direct impact on your credit rating when you borrow a cash advance, it can have indirect effects. An advance on a credit card will raise the outstanding balance and credit utilisation ratio, the latter being something credit rating companies take into account when calculating your score. This works in the following way:
$500 owed on a credit card with a limit of $1,500 gives a credit utilisation ratio of 30%.
A cash advance of $300 will lift the balance to $800 and the credit utilisation ration to over 53%.
In general, a utilisation rate of more than 40% will be seen as presenting a higher credit risk, and will impact on your overall score
The pros and cons of cash advances
A cash advance may seem like a reasonable option for someone who would otherwise have difficulty obtaining credit and requires funds urgently, but it should only be considered if a reasonable plan to repay the money quickly is in place.
Although it comes with risks, a credit card cash advance is a better option than a payday loan, thanks to the latter’s extremely high interest rates and the greater flexibility offered by a credit card cash advance.
A cash advance is a bad idea in the following circumstances:
If you are about to declare bankruptcy.
In order to pay a credit card bill – borrowing of this kind is an expensive way to deal with bills and may well lock you into a spiral of increasing debt.
To fund a purchase that you otherwise couldn’t afford – building up debt simply to satisfy the need to buy something is a dangerous way of running your finances and suggests an unhealthy relationship to debt and spending.
If used to tide over an emergency, then a cash advance can be a useful means of borrowing money. If it becomes a regular event, however, it would be wise to take a long, hard look at your finances.
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