Taking out a cash advance loan on your credit card might not seem like a big deal, since you already borrow money from your credit card balance when you use your card to buy a pack of gum or some new sneakers. But cash advance loans are different, and they can carry risks for borrowers.
Here’s why: While a cash advance from a credit card company is still a loan, it typically comes with a different set of rules about paying back that money, including fees, a higher interest rate, and a more aggressive schedule for accruing interest.
What is a cash advance?
A cash advance is a short-term loan from a credit card company. The money that you receive as an advance will come from your available credit and count toward your credit limit. When you’re approved for a credit card, the company will let you know your credit limit, as well as your cash advance limit.
To withdraw cash from your credit card’s line of credit, you can go in-person to the bank, or request a Personal Identification Number (PIN) from your credit card provider. With that PIN, you can withdraw the cash from an ATM. Credit card companies may also issue blank convenience checks, which can be cashed for cash advance loans.
What are the risks associated with taking a cash advance?
The biggest risk that comes with taking a cash advance from a credit card company is the interest on that advance, which can be up to twice as high as the average interest rate for credit card purchases.
Here’s the other critical thing to keep in mind. When you buy something with a credit card, you’re given a month-long grace period where that money doesn’t accrue interest. After a month, the bill starts accruing interest.
That’s not the case with a cash advance. There is no grace period and interest starts accruing—or accumulating—immediately, which can make paying off the advance difficult. Interest on the loan snowballs. The longer you take to pay a loan off, the more interest it accrues, which can make staying on top of that debt difficult.
On top of the interest, banks and credit card providers usually charge fees to process the request for a cash advance. These fees are typically 3% to 5% of the amount taken out as an advance.
Here’s an example: If you take out a $1,000 cash advance with a compound interest rate of 26% and a 3% fee. If you pay that advance back in 30 days, you will still owe $30 in the 3% fee and $21.90 in interest, totalling $1,051.90. The longer you take to pay back that advance, the more it will cost you, as the interest accrues every day.
In comparison, if you spent $1,000 with a credit card with an 18% interest rate and paid the bill within 30 days, you would only owe nothing besides the $1,000 because of the grace period.
Alternatives to taking a cash advance
If you have savings, you may want to consider pulling cash from that account instead of requesting an interest-bearing cash advance.
Other options include borrowing money from a family member or a friend, and finding other ways to earn cash, perhaps by selling clothes or furniture online, or doing short-term freelance or gig work. You may also want to take a look at your credit card accounts. If you have cash back points from a credit card, you may be able to deposit those points as cash right into your account.
How to avoid a cash advance
The best way to avoid taking out a cash advance from a credit card company is to make sure that you are regularly saving money to an emergency fund or a rainy-day fund. Ideally, this fund should have $500 to $1,000, which you could use instead of relying on a cash advance.
Saving money for the short-term and long-term should be a part of your budget. Make sure you build a budget that accounts for monthly fixed expenses, variable expenses, and money for saving and investing.
Making room for savings in your budget can help you when you need to access cash quickly.