It’s a fact that unexpected events can derail your finances, and if you have minimal savings, it can be a real struggle to make ends meet. Unsurprisingly, many people turn to personal loans, with payday and installment loans emerging as two widely favored choices. While both can help you get through a tough financial time, they have significant differences that are crucial to consider before choosing one over the other.
In this blog, we’ll delve into the features of payday loans vs. installment loans and help you determine the right fit.
Payday Loans: Pros and Problems with Short-term Loans
Payday loans are short-term loans with high fees and interest rates typically due on the borrower’s next payday. Here are the advantages and disadvantages of payday loans:
- Quick access to cash with same-day turnarounds.
- No credit check is required, which can benefit those with poor credit.
- Direct access to checking accounts can lead to overdraft fees if the account balance is too low.
- Easy access to payday loans can result in them being granted to individuals who cannot afford to repay them.
- High-interest rates and fees make payday loans more expensive than other forms of borrowing.
What Are Installment Loans?
Installment loans are a type of loan that involves receiving a one-time payment of a specified amount and making fixed monthly payments over a set period. Personal loans are one example of an installment loan and typically have a term of around 12 months. Other categories of installment loans include mortgages, auto loans, student loans, and medical bills.
Benefits of borrowing at lower rates through installment loans:
- Allows borrowers to finance a big purchase over a long period.
- Payments remain fixed throughout the loan term.
- It can help improve a borrower’s credit score if payments are made on time and in full.
- Installment loans can be expensive due to fees like origination, late and insufficient fund fees.
- If you cannot manage repayments, it could lead to lasting financial problems.
What Are More Affordable Alternatives?
- Payday alternative loans: Provided by credit unions for their members, these loans are for a small amount (typically below $1,000) and are repaid over one or a few months.
- Credit-builder loans: These loans are designed for borrowers with low or no credit, and they disburse funds into a locked savings account that you’ll only get access to after making all installment payments towards the loan.
- Ask your employer for an advance: Some employers offer paycheck advances to their employees but keep in mind that your next pay period will be at a reduced amount.
The Key Differences between Payday and Installment Loans
1) Borrowing Costs
Payday loans often come with exorbitant interest rates that can be as high as 600%, while installment loans usually have interest rates ranging from 3% to 36%.
2) Credit Requirements
Installment loans are typically only available to borrowers with good credit scores, as lenders want to ensure they can repay them. On the other hand, payday loans are often marketed to people with poor credit, making it easier to obtain one.
3) Loan Amount
Payday loans are usually small-dollar loans, with amounts typically limited to around $500. In contrast, installment loans can range from a few hundred dollars to as much as $100,000.
4) Repayment Terms
Payday loans typically require borrowers to pay back the full loan amount, plus interest and fees, by their next paycheck. Installment loans are repaid in regular installments over a longer period, usually 2 to 5 years.
5) Risks Associated
Payday loans can be considered predatory, as lenders often don’t consider a borrower’s ability to repay the loan, and the loan won’t help build credit. In the case of installment loans, defaulting on secured loans can result in the loss of property.
Which Is the Better Option for You?
Payday loans can lead to a recurring pattern of indebtedness, while installment loans are a better option if you’re eligible. “Short-term installment loans” are often just payday loans in disguise, so it’s important to evaluate terms and fees carefully. Payday loans are predatory and should be avoided as they can trigger additional fees, resulting in lawsuits, potential bankruptcy, and harassment from debt collectors.
Having a contingency plan for unforeseen financial emergencies is crucial since they can arise for anyone at any time. While personal loans like payday and installment loans can be helpful in such situations, it’s crucial to understand their differences and weigh their pros and cons before choosing one. It’s better to be prepared with a solid financial plan than to rely on short-term solutions that can lead to long-term consequences.