Cash Advance: Definition, Types, and Impact on Credit Score

What Is a Cash Advance?

A cash advance is a short-term loan from a bank or an alternative lender. The term also refers to a service provided by many credit card issuers allowing cardholders to withdraw a certain amount of cash against their available credit. Cash advances generally feature steep interest rates and fees, but they are attractive to borrowers because they also feature fast approval and quick funding.

Types of Cash Advances

There are a variety of cash advance types and lenders, but the common denominators among all of them are the stiff interest rates and fees.

Credit Card Cash Advances

The most popular type of cash advance is borrowing on a line of credit through a credit card. The money can be withdrawn at an ATM or, depending on the credit card company, from a check that is deposited or cashed at a bank. Credit card cash advances typically carry an interest rate that is higher than the rate for regular purchases. What’s more, the interest begins to accrue immediately; there is no grace period.

These cash advances usually include a fee as well, either a flat rate or a percentage of the advanced amount. Additionally, if you use an ATM to access the cash, you often are charged a small usage fee.

Along with separate interest rates, credit card cash advances carry a separate balance from credit purchases, but the monthly payment can be applied to both balances. However, if you are only paying the minimum amount due, the card issuer is allowed by federal law to apply it to the balance with the lower interest rate. As that is invariably the rate for purchases, the cash advance balance can sit and accrue interest at that high rate for months.

Any payments over the minimum payment must be applied to the highest interest balance, so if possible, paying more than the minimum is advisable.

In most cases, credit card cash advances do not qualify for no- or low-interest-rate introductory offers. On the plus side, they are quick and easy to obtain.

Merchant Cash Advances

Merchant cash advances refer to loans received by companies or merchants from banks or alternative lenders. Typically, businesses with less-than-perfect credit use cash advances to finance their activities, and in some cases, these advances are paid for with future credit card receipts or with a portion of the funds the business receives from sales in its online account. Rather than using a business’ credit score, alternative lenders often survey its creditworthiness by looking at multiple data points, including how much money the merchant receives through online accounts like PayPal.

Payday Loans

In consumer lending, the phrase “cash advance” can also refer to payday loans. Issued by special payday lenders, loans can start anywhere from $1,000 to $50,000, but they come with fees (typically around $15 per $100 borrowed) and interest rates exceeding 100%. Rather than taking into account the borrower’s credit score, the lender determines the amount of the loan based on local state regulations and the size of the applicant’s paycheck. If the loan is approved, the lender hands the borrower cash; if the transaction takes place online, the lender makes an electronic deposit to the borrower’s checking or savings account.

The loans are extremely short-term—they must be paid back on the borrower’s next payday unless they wish to extend the loan, and in that case, additional interest is charged. Unfortunately, many do: More than 80% of all payday loans are rolled over within 30 days of the previous loan, according to a 2014 study by the Consumer Financial Protection Bureau (CFPB).

Payday loans are only legal in 26 states, and of those, 16 states require lenders to offer extended payment plans that help mitigate the excess rollover fees. However, many payday lenders don't advertise these payment plans, instead hoping that borrowers will rack up excessive fees.

The process can be quicker, if more complex, than securing a credit card cash advance. To obtain a payday loan, you write a postdated check made out to the payday lender for the amount you plan to borrow, including the fees. The lender immediately issues the borrowed amount but waits to cash your check until payday arrives. Some electronically minded lenders now have borrowers sign an agreement for automatic repayment from their bank accounts. Lenders usually ask that you provide personal identification and proof of income when you apply.

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

Do Cash Advances Impact Your Credit Score?

Taking out a cash advance has no direct impact on your credit or credit score, but it can affect it indirectly in various ways.

First, if you take the advance from a credit card, it will raise your outstanding balance, which will raise your credit utilization ratio, a measure that credit scoring models use to calculate your score. If you owe $500 on a $1,500 limit card, for example, your credit utilization ratio is 30%. However, if you take out a $300 cash advance on that card, the balance will jump to $800, resulting in a credit utilization of more than 53%. High utilization rates are a big indicator of credit risk.

As noted earlier, a cash advance usually has a high-interest rate. If this affects your ability to pay the monthly charges promptly, that also could affect your credit score. And if the cash advance puts you over the card’s credit limit, your credit score can be dinged. Even after the balance is paid down, your credit report will show the highest balance reported, and other potential lenders will see that you were over the limit at one point, which could hurt your ability to get new credit.

Cash Advance Pros and Cons

A credit card cash advance could be a reasonable option for someone who has an emergency need for money and limited resources for getting it, especially when that person has a clear and reasonable plan for paying back the money in a short period. It is, for example, a better option than a payday loan or a car title loan, due to the exorbitant triple-digit interest rates those loans typically carry and the greater payoff flexibility that comes with credit card debt.

But cash advances would be a bad idea under these conditions:

• Just before declaring bankruptcy: New credit card debt does not magically disappear in bankruptcy. Your creditors and a judge will examine your debts, including the dates and types. Once you know or have a strong inclination that you’ll soon file for bankruptcy, credit card use of any kind may be considered fraudulent. A cash advance immediately prior to filing is very likely to be challenged by the card issuer, and that account may be excluded from the debts that are forgiven in bankruptcy. 
• To pay a credit card bill: A cash advance is a very expensive way to pay bills, and the risk of falling into revolving debt cannot be ignored. The potential to pay many times the amount of the original advance (in interest charges) is very real. Furthermore, in addition to the higher interest rate, there are those additional fees that everyday credit card purchases are not subject to.
• To buy something you can’t afford: Going into debt to satisfy a desire is not just financially dangerous; it’s emotionally detrimental. A person who thrives on immediate gratification and the temporary emotional lift of a big purchase will eventually feel regret (and possibly depression, anxiety, stress, and other debilitating emotions) when faced with the debt—the more compulsive the purchase, the more pronounced the regret.

The Bottom Line

Cash advances aren’t alarming when used infrequently, but they are at best short-term solutions to cover emergencies. If they are becoming a habit, or if you find you regularly need a cash advance to make ends meet, then drastic budgeting and spending changes are in order.