What is a Credit Card Cash Advance and How Does It Impact Your Credit Card Debt?
Find the credit card agreement that came with your new credit card. It's a small document that's likely been folded up and features a whole lot of numbers and fine print.
Take a close look at it. You'll see that you have two credit limits and two APR's: one for credit card purchases and one for a cash advance.
Banks offer credit card holders the option of forgoing the swipe and using cash instead. You might be excited by the idea of money even when your checking account balance is low. Put the credit card down and look at your terms and conditions again.
The industry calls the option a credit card cash advance. Just like the credit card itself, it gets people in trouble when misused. Why is such a good thing so bad? Because the cash borrowed from a credit card comes with a high price that too often sends your balance spiraling out of control.
Think twice before using a cash advance. Here's why.
What Is a Cash Advance?
A credit card cash advance is a service offered by most credit card issuers to allow you to withdraw cash one of three ways:
- From an ATM (using a PIN)
- In-branch at the bank issuer
- Online to another account at the same financial institution
Once withdrawn, the cash is yours to spend as you please.
Credit card issuers treat cash advances differently from a regular credit card purchase in two ways. First, they put a limit on the amount of cash they allow you to take. You won't be able to take out more than your credit limit. Very often, the cash limit makes up only a percentage of your total limit.
Second, banks tack on additional fees including a cash advance fee and a higher interest rate. Cash advance fees may be a set fee ($10) or a percentage of the total withdrawal (5 percent).
In addition to those fees, the APR for cash advances is also higher than a card transaction. Look at your terms and conditions. Your APR on credit card purchases may range from 10 to 18 percent, but your cash advance APR may over 20 percent.
Seventy-nine percent of all credit cards assign an APR of over 20 percent to these transactions. The average interest rate is 23.53 percent, which is 8.5 percent higher than the average APR for swipe transactions.
No Grace Period
It's not enough that cash advances feature more fees and higher interest rates. One of the most important built-in debt management tools also disappears as soon as you hit the ATM.
On credit transactions, you get a grace period to pay back credit card debt interest-free. The time allotted depends on the issuer. The average grace period lasts 21 to 25 days from the first day of the billing cycle.
If you spend $500 on a credit card and pay it off 14 days later, then it's likely you won't pay interest on the balance.
The same is not true with cash advance options.
Visit the ATM and begin paying that sky-high interest rate as soon as the cash is in your hand. Moreover, you may keep paying it until the cash advance is squared away.
A lack of grace period isn't your only problem. The way banks apply payments to your account also creates nightmarish conditions for those with unaffordable balances.
Split Payments and Cash Advances
Banks split the balance on your credit card in three ways: purchase transactions, cash advances, and balance transfers. Each has a different set of terms and rates, which means banks treat them differently.
You might have three balances, but you only make one payment. Here's where things can go very wrong.
Every time you make a payment, the bank applies the amount to the oldest part of the balance. Let's say your current balance is $3,000. A sum of $200 would be sent not to what you spent last month, but what you spend six months or even a year ago depending on the age of the oldest unpaid transaction.
If $500 of your balance is a cash advance from last week, then some issues make you need to pay off $2,500 before your payments apply to the cash advance.
You pay interest on the cash advance in all that time until your payment finally applies to it.
Now, not all credit card companies do this, but they can when you only pay the minimum payment each month. Despite reforms like the Credit CARD Act, issuers may legally apply the minimum payments only to the balance with the lower interest rate.
Your quick cash injection might cost you 27 percent - or even more - of the money you borrowed if you only make the minimum payment and it takes a year to reach that part of the balance.
Cash Advances Are the Most Expensive Credit Transaction
You could pay as much as 25 percent APR on any given cash advance transaction plus all the extra fees. Why are these transactions so expensive?
First, added fees make money for the bank. Interest isn't the only way credit card issuers generate cash. Every swipe comes with an interchange transaction fee that the bank receives from the merchant.
When you use an ATM to withdraw cash, they don't receive the 1-3 percent transaction fee. So, the added fees ensure they still profit from lending the money.
Second, banks view a credit card cash advance as a financially unstable move. Their view is that if you need to borrow cash from your credit card, then you are a more significant credit risk.
Credit card issuers base their terms on your creditworthiness. Things like your debt-to-income ratio profoundly impact how much you borrow and how expensive it is to acquire it.
People with plenty of savings and who use debt responsibly often get the best deals. Banks believe those people have a higher likelihood of paying on time.
If you are willing to borrow cash at a high-interest rate, banks place you in a higher risk profile.
So, such a high APR isn't there because the bank wants to penalize you for taking out cash. It's there to capitalize on interest while they can because a profile like this is more likely to default on a credit card.
Alternatives to Taking Cash Out of Credit Card
Credit card cash advances are expensive and have the potential to make a difficult situation worse. These advances are only worthwhile if it is an emergency and you need cash in the next few minutes and if you pay them off immediately.
Other options for getting cash fast exist. Here are a few alternatives to consider before hitting the ATM with your credit card:
1. Ask from Family, Friends or Employers
Need extra money to make it to payday? Your best bet is to let go of your pride and ask someone you know. Family, friends, and employers are unlikely to charge you fees or assess high interest rates.
2. Personal Loan
Think you won't qualify for a personal loan? Think again.
Personal loans help cover purchases that are too expensive to pay for all at once. Secured loans help pay for big-ticket items like cars or student loans. An unsecured loan comes with a higher interest rate and requires proof of income, but they're better for cash injections.
These loans won't get you the cash you want in five minutes, but they are far more forgiving than the credit card fees.
3. Payday Loans
Payday loans help cover life's little emergencies like overdue bills or unexpected expenses. These loans are smaller than personal loans, but they are more available to those with low credit scores. You need less paperwork and spend less time getting one of these loans.
Payday loans come with fees and high interest rates, and terms and conditions vary according to the lender. Still, unlike cash advances, your payments go directly to the loan. It avoids the trap of paying off old balances while your high APR balance sits untouched.
Stick to Swiping and Avoid Credit Card Cash Advances
A credit card cash advance almost always costs more than its worth. The fees, interest rates, and lack of grace period ensure that you'll struggle to pay it back unless you already have the money in the first place.
And if you already had the cash, then you don't need to pay those fees at all. Save money every chance you get.
Stick to swiping your card and stay away from the ATM. Remember, there are more forgiving alternatives to the cash advance that are less likely to send your credit card debt spiraling out of control.
Want to learn more about ways to borrow money - even with bad credit? Visit our blog for more resources on credit, debt, and loans for bad and no credit.