Cash advance loans: 4 reasons to be cautious

Cash advance loans are short-term loans that target people who have an immediate need for cash. They also may go by other names — like payday loans, guaranteed loans or no-credit-check loans — and there’s no shortage of them online and at storefront locations.

But cash advance loans typically come with high fees and the danger of being trapped in a cycle of debt.

Before you take out a cash advance loan or any other type of short-term loan, here are some important things to consider.

What is a cash advance loan?

A cash advance, or payday loan, is a short-term loan that typically promises a quick application process in exchange for quick money if approved.

Here’s how they typically work: You’ll fill out a paper or online application, and if approved, the lender will give you the amount you’re borrowing (minus certain fees). In order to get the funds, you may have to write a check to the lender for the amount of money that you want to borrow, plus the fee. At your next payday, the lender will either debit your checking account for the amount you borrowed and any additional fees — if you’ve authorized them to do so — or the lender would cash the check, if you’ve written one.

Lenders will typically ask to see proof of an active bank account or prepaid debit card account, income and age (you must be at least 18 to borrow). Maximum loan amounts allowed by state law vary, and can vary by lender, but it’s common to see a maximum of $500, though some range higher and lower.

4 reasons to be cautious with cash advance loans

Cash advance loans are often advertised as quick cash that can be used to pay off unexpected bills. But if you’re like most short-term borrowers — dealing with ongoing cash shortfalls and having trouble keeping up with other bills — the high costs of a cash advance loan may make your situation worse. In fact, because of this risk, payday loans are completely prohibited in more than a dozen states and Washington D.C.

Here are four more reasons to be cautious of cash advance loans. 

1. They come with finance charges

Cash advance loans come with borrowing fees that can equate to APRs in the range of 300% to 500%, but these can go much higher. You may not realize the rate is that high when you take out a cash advance loan, because loan costs typically are advertised as a flat dollar amount. But take a closer look: Borrowing, say, $500 with a $75 interest and finance fee and a 14-day term would be the equivalent of taking out a loan at an APR of 391%. Compare that to the national average APR on a standard personal loan with a two-year term, at 9.34%, and you get an idea of how expensive it is to borrow with a cash advance loan.

2. Expensive fees can trap you in debt

Adding to those high fees, if you can’t pay back the loan on time, the lender may offer you a new loan — with a new fee. Many borrowers end up “rolling over” or refinancing the debt. The average payday or cash advance borrower rolled over a loan nine times during a 12-month period and paid a total of $458 in fees alone, according to a Consumer Financial Protection Bureau report.

3. There’s likely no credit check but also no credit-building

Reputable lenders typically check your credit and your ability to repay a loan before you’re approved for financing. But cash advance lenders usually don’t perform a hard credit inquiry during the approval process. And while that might be appealing, know that a cash advance loan won’t necessarily help you improve your credit either, because lenders usually won’t report your payments to the three main credit bureaus.

4. You may end up overdrawn

More than a quarter of payday loan borrowers said that payday lenders have overdrawn from their checking accounts, according to a study by Pew Charitable Trusts. Overdrafts can result in fees from both the lender and the bank, which contributes to the debt cycle even more.

Alternatives to cash advance loans

If you’re having financial difficulties and don’t know where to turn when you need money quickly, you may feel like a cash advance loan is your only option.

But there are some alternatives that may be better for you. Here are a few.

• Payday alternative loans: These small-amount loans, which you can find at many federal credit unions, come with several consumer protections. For example, under National Credit Union Administration guidelines, application fees are capped at $20, the loan can’t be rolled over into a new loan, and the terms range from one to 12 months.
• Credit card cash advances: A credit card cash advance lets you take out cash against your credit card’s line of credit. Although costly — you’ll typically pay a fee and a higher interest rate than what you pay on credit card purchases — they’re still less expensive than a cash advance loan if they’re repaid promptly.
• Credit counseling: Look for a nonprofit credit counselor that can explain your options and help you create a long-term financial solution to any debt or cash-flow issues.

Bottom line

Cash advance loans are simply payday loans dressed up as a convenient way to access cash — but they have expensive fees that can contribute to trapping borrowers in a cycle of debt that’s hard to get out of.

High-interest, high-cost loans like cash advance or payday loans should only be considered as a last resort when you’ve exhausted other alternatives. But if you decide that a cash advance loan is what you need, before applying make sure you work what you’ll owe into your budget for the next payday so that you can avoid the cash-advance trap.