The Right and Wrong Way to Use a Cash Advance

Everyone has been there at some point: There are bills piling up, there are necessities still to buy, and there just isn’t enough money in the checking account to pay for everything. Bank loans are far too slow and formal for such occasions, and it can be messy asking friends and family for financial help. Many times, the only recourse is the cash advance.

Cash advances are short-term loans provided by certain lenders, including credit card companies and banks. However, cash advances shouldn’t be everyone’s first payment choice when it comes to getting money fast. Read on to learn more about the process of applying for cash advances, the advantages and dangers, and ways to use them wisely.

Types of Cash Advance

Before we delve into how to get and use a cash advance, it is important to note that there are several different types. Though all cash advances have similarly high interest rates, they differ in their origin, duration, and amount.

The most common type is the credit card cash advance. Cardholders can use their lines of credit to withdraw cash from ATMs. However, card companies rarely allow cardholders to withdraw their total credit amount, and almost all credit cash advances have 1 to 7 percent higher interest rates than normal credit purchases. The time it takes to repay a credit card cash advance depends entirely on the cardholder; paying the minimum each month could contribute only to the regular balance while the cash advance balance continues to accrue substantial debt.

Payday loans are another familiar type of cash advance. Usually, payday loans cannot exceed about $1,000, but their interest rates can soar well over 100 percent, so even though the amount loaned is relatively small, the payments can quickly become disastrous. Cash seekers apply for a payday loan with merely a post-dated check for the advance plus any fees, and the lender waits to deposit the check until payday – hence the name.

Merchant cash advances are available to small-business owners who need cash fast to keep their company afloat. Unlike small-business loans, this type of cash advance usually requires no credit check, no collateral, and no termination date. In exchange for a percentage of the borrower’s business’s future credit card sales, lenders provide substantial amounts of cash – in the several tens of thousands of dollars – but most balances are paid off within six to 12 months.

Additionally, there are a handful of less popular cash advance options through employers and banks, but because these are not always available and vary widely by terms and fees, it is difficult for us to give concrete information on them. Those interested in these alternative options should consult their employers and banks directly.

The Wrong Way

Cash advances for personal use are costly in a number of ways. First, most lenders require fees of between 2 to 5 percent before a borrower can even lay hands on the money. Second, most lenders start accruing interest on the cash advance the moment the money is withdrawn, which means it is paramount to pay the advance back as quickly as possible.

Suffice to say that taking out cash advances frequently to pay for everyday expenses, including regular bills and purchases, is not financially wise. This is true for merchant cash advances, as well. Plus, small-business owners certainly should not attempt to finance their ventures using cash advances, as starting a business in so deep a hole is never promising. In general, cash advances should be avoided nine times out of 10.

The Right Way

However, cash advances exist for a good reason. The high cost of cash advances does not automatically mark the loans as eternally evil and always to be avoided. In fact, cash advances can be a godsend during emergencies – as long as the emergency fits a particular scenario.

When it comes to personal use, advances are only appropriate when cash is the only acceptable form of payment and when the borrower is confident in his ability to earn back the money within a month. Expenses that are worthy of such risky loans are those a borrower needs to live and work – for example, a car battery or a camera for a hobby-business. Even then, a personal borrower should seek alternative sources of income, including family members and friends, for amounts higher than $1,000.

Merchant cash advances are a slightly different story. Of course, financial emergencies certainly warrant application for the fast cash; a roof collapse or a broken window must be fixed quickly to continue doing business safely. Though emergencies are still the most appropriate times for these high-interest loans, there are a number of advantages that make cash advances appealing in other situations.

For example, times of prosperity may necessitate excess spending: One business owner who was struggling to maintain his restaurant and keep up with demand used a cash advance to buy extra equipment, knowing he would be able to pay off the loan in a matter of months.

The takeaway for all cash seekers is that advances are viable and volatile loans, but they can be incredibly beneficial when chaos strikes and fast action is imperative.

The Future of Cash Advances

During the recession, cash advances became exceedingly unpopular, and across the economy, the number of cash advances taken quarterly dropped more than 35 percent. Fearing the repercussions on their credit scores and savings accounts, borrowers stayed away from all sorts of loans during the period after 2008.

Yet, the recession was actually positive for those who require cash advances. The Credit CARD Act of 2010 restricts how credit providers can penalize borrowers who default on their loans. It is entirely possible that this type of regulation will extend to other types of cash advances, including the dreaded and dangerous payday loan.

A cash advance is not, and never will be, a carefree method of paying bills, but it is not a terrifying and shameful financial option either. As long as borrowers remain aware of the terms of their advances and stay ahead of their payments, they should be able to get the cash they need now without significant stress later.

Melissa Thompson writes about a wide range of topics, revealing interesting things we didn’t know before. She is a freelance USA Today producer, and a Technorati contributor.