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Installment Loans: More Mileage for Your Money (Part 1 of 3)

Ask a teenager if they’d rather drive a minivan or an F1 racer, and you know what the answer is going to be. Easy decision. Of course, the choice is easy for adults too. Given the option between a solid, dependable ride and a deathtrap, most adults would choose the safe and reliable vehicle.

The difference between something safe and something wildly dangerous is exactly the difference between an installment loan and a payday loan. While a payday loan promises to get you from “in debt” to “out of debt” at warp speed, that promise rarely holds true in reality. More often than not, these short-term loans lead to debt that spirals out of control. On the other hand, installment loans are safer, more reliable, and less likely to blow up in your face.

In this blog series, we are going to take a peek under the hood to see just how these loans work. First things first, let’s cover some basics:

Payday Loans: Make Sure to Wear Your Seatbelt

It’s right there in the name: these short-term cash loans are designed to tide borrowers over until their next pay day. They’re pretty easy to get, which is one reason they seem so attractive. Oftentimes, a potential borrower needs little more than a bank account and a photo ID in order to qualify for one.

Payday loans generally have a maximum limit of $500, an average repayment term of 14 days, and charge an interest rate of $15 per $100 borrowed. And while that interest rate doesn’t look too bad at first, it’s because that 15 percent rate only applies to the stated repayment period. To truly compare costs, we can’t just look at the simple interest rate. Instead, we have to look at another figure: The Annual Percentage Rate, or APR. With a 15 percent interest rate over a two-week period, the standard APR for a payday loan comes to 390%. Yikes!

If they are so expensive, then why do people use them? Well, the majority of payday loan borrowers are people who don’t have a ton of options when it comes to getting a loan. These are people who don’t have a great credit score, and their average income is only $26,167.[1] Most traditional lenders think these types of borrowers are too “risky” to lend money to. Payday lenders, on the other hand, see them as perfect targets for their high-cost products. Read more in our eBook How to Protect Yourself from Payday Loans and Predatory Lenders.

Payday loans are also designed to be paid off in one lump sum payment, which can be difficult for borrowers to afford. Installment loans, on the other hand, are designed to be paid off gradually, over time …

Installment Loans: Even the Cup Holders Are Spacious

Like payday loans, installment loans have a preset repayment term. Unlike payday loans, this repayment term is usually a minimum of six months. Mortgage and auto loans are most often set up as installment loans, as are most personal loans. While payday loans are usually capped at $500, most installment loans are available for much larger amounts.

Installment loans come with a series of regularly scheduled payments, usually once-a-month. Each payment is the same size as every other payment, and each payment consists of two parts: one part of the payment goes towards paying the principal, and the other part goes towards paying the interest. With every payment made, the amount owed on the loan grows smaller. This type of structure is referred to as “amortization.” You can learn more about whether an installment loans is right for you in Top 5 Questions to Ask Before Taking Out an Installment Loan.

Personal installment loans from traditional lending institutions, like banks and credit unions, are something that people with bad credit are probably not going to qualify for. However, there are also many lenders, like OppLoans, that offer the security of the installment loan model to borrowers with less-than-stellar credit.

There, now that we have the basics covered, check back tomorrow for Part II: The Rollover Road Trip!

References:

  1. “Payday Loans and Deposit Advance Products.” Consumer Finance.Gov. Accessed August 22, 2016. https://files.consumerfinance.gov/f/201304_cfpb_payday-dap-whitepaper.pdf.