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When unexpected expenses throw a curveball at your budget and you need cash fast, a payday loan or installment loan may seem like a quick solution. But payday loans are almost always a bad idea.
Before making a decision, you should know the difference between these types of personal loans and which one is better for your finances.
Payday and Installment Loans
Payday loans and installment loans are short-term solutions when you need cash quickly. The main differences are the ease of approval, the amount you can borrow, and the term over which you repay the loan (including fees and interest).
Payday loans are usually small, with a maximum amount of $500. Installment loans have a higher initial balance. Payday loans are usually required to be repaid in a lump sum on your next payday. They often must be repaid within 10 to 14 days of receiving the loan. Installment loans are usually repaid over months or years.
While all loans carry some risk, installment loans are generally much less risky than payday loans.
| Payday Loans | Installment loans | |
|---|---|---|
| Collateral Requirements | Unsecured (no collateral required) | These are typically unsecured, although some lenders offer secured loans. |
| Loan amount | Usually under $500 | Up to $100,000 |
| Funding timeline | Same day to 1 business day | Usually within 3 business days |
| Repayment Terms | Paid in one lump sum on your next payday (or within 14 days) | Paid over a period of months or years |
| Interest and fees | A flat fee ranging from $10 to $30 per $100 borrowed, depending on state regulations. | They are usually much less than payday loans, but they vary depending on your credit score and the lender. |
| Application Procedure | Fast and minimal requirements | More thorough credit checks are needed |
| Impact on credit | If you make payments on time, there will be no impact, but defaulting on payments can lower your credit score. | Making on-time payments can improve your credit rating, but missing payments can negatively impact your credit score. |
How do payday loans or short-term loans work?
Payday loans are short-term, high-interest loans designed to provide quick cash to borrowers in need. They are typically used as a lifeline for people facing urgent financial situations who don’t have access to traditional lending options.
But because of their high interest rates and their tendency to trap people in a cycle of debt, such loans are effectively or explicitly illegal in about half of U.S. states.
- Apply: Most payday loans have a simple application process and few requirements. Borrowers usually must provide identification, prove they have a steady income, and provide checking account information.
- Approval: Loan approvals often take just minutes, and funds are usually transferred the same day or within 24 hours.
- Amount: Loan amounts are typically limited to $500 or less, depending on state regulations.
- repayment: Payday loans have short and strict repayment periods. The borrower must repay the loan amount plus fees by the next payday, usually within 10 to 14 days. This is often done by post-dated check or through authorizing automatic deductions from the borrower’s checking account.
If you can’t repay the loan, the lender may suggest that you “refinance” it by getting a second payday loan in an amount large enough to cover both the original amount and their fees. This option often leads to a vicious cycle where your debt continues to grow and grow.
The speed and ease of obtaining a payday loan is appealing, but high interest rates and short repayment periods can create a financial burden.
Payday Loans Pros and Cons
Before taking out a payday loan, weigh the potential benefits and drawbacks. Approximately 12 million Americans take out payday loans each year. But these loans can have a devastating effect on your finances.
Strong Points
- Payday loans are a service that allows you to get cash quickly. Funds are often available the same day, which can be useful in emergencies.
- Getting approved for a payday loan is easy: Minimum credit requirements make payday loans available to individuals with poor credit or no credit history.
- The application process is quick and easy. Typically, only basic information such as proof of identity and income is required.
Cons
- Payday loans are expensive. Fees are often high, making this a very expensive borrowing option, with flat-rate fees sometimes running at an annual percentage rate (APR) of 600 percent or more.
- Payday loans can trap you in a cycle of debt. People who are always tight on money can turn to payday loans. The initial loan is often rolled over into a new, larger loan with the same fees and higher interest rates, making it even harder to pay off the loan.
- Lenders may have direct access to your checking account. Lenders will often ask for your authorization to pull payments directly from your bank account, and if you don’t have enough money in your account, you may be charged an overdraft fee.
- Payday loans are limited in amountThe amount you can borrow is often limited to $500 or less, which may not be enough if you need a larger amount of money.
- Payday loans can be predatory: Payday lenders don’t check credit scores and often lend to people who can’t repay the loans. Lenders may only care about collecting high fees and interest rates.
How do installment loans work?
Installment loans offer a more structured, affordable borrowing option. These loans offer larger amounts and predictable monthly payments over a longer period of time.
- Apply: The application process for installment loans is more thorough than that for payday loans. You will have to provide more information, such as proof of identity and a steady income, and undergo a credit check. This information allows the lender to determine your ability to repay the loan.
- Approval: If you apply online, approval usually takes just a few minutes or hours, and loans are usually issued within one to three business days, though some lenders offer same-day loans and others warn that it could take up to two weeks.
- Amount: Installment loan amounts can range from a few hundred dollars to as much as $100,000, depending on the lender and the borrower’s creditworthiness.
- repayment: The terms of an installment loan are more favorable for the borrower than a payday loan. The borrower repays the loan in a set amount every month for a period of months or years, depending on the loan agreement. Interest rates on installment loans are also generally lower than payday loans.
This structured repayment plan makes it easier for borrowers to budget and manage their finances while repaying their loans.
Overall, installment loans offer a more sustainable solution than payday loans.
Installment loan pros and cons
Installment loans are better than payday loans, but all types of borrowing carry risks. Here we explain the pros and cons of installment loans.
Strong Points
- Installment loans have lower interest rates. Installment loans generally have a much lower APR than payday loans, making them more affordable.
- Managing your payments is easy: An extended repayment term allows you to make smaller, more manageable payments over a period of months or years. Your monthly payments are fixed, making it easier to budget.
- Making payments on time builds credit. Most installment loans are reported to the major credit bureaus, so making payments on time will have a positive impact on your credit score.
- Installment loans can be used for a variety of purposes. Installment loan funds can be used for debt consolidation, large purchases, unexpected expenses, and more.
Cons
- Potential fees: Origination fees, late fees and non-sufficient funds fees can add to the overall cost of a loan, so it’s important to compare lenders to find the lowest-cost option.
- Long-term commitment: Monthly payments can stretch out over several years, requiring long-term financial planning and discipline.
- Risk of additional indebtedness: Taking out a large loan increases your total debt, putting your finances at risk if your circumstances change and you can’t make the payments.
- Credit check required: A credit check is part of the application process. Those with low credit scores may not qualify.
- Things that can negatively affect your credit: Missing or defaulting on your loan payments can negatively impact your credit score and may result in collection action.
Payday Loan Alternatives
If your poor credit score means you can’t get a traditional installment loan, consider working with a reputable credit repair company to improve your score rather than taking out a payday loan.
If you need cash urgently and can’t wait, it may be wise to consider alternatives to payday loans.
- Payday Alternative Loans (PAL)Some credit unions offer payday alternative loans. These loans are small loans, usually less than $1,000, that you pay back over a few months.
- Ask your employer for an advanceYour employer may offer you a salary advance.
- Negotiate payment plans with creditorsContact your creditors and explain your financial situation. They may have hardship programs or payment plans that can help you.
- Ask your family and friendsAsking family or friends for a short-term loan can help you avoid high interest rates and fees. Be sure to draw up a contract before accepting any money so everyone is protected.
Conclusion
If you’re in financial difficulty or need emergency funds, payday loans aren’t your only option. Installment loans offer more flexible repayment schedules and lower borrowing costs.
A short-term loan may seem like a solution when you need cash quickly. But if you’re not careful, taking out a loan can have negative effects on your long-term finances. Research your options before making a decision.
