With Bad Credit Loans, the Size of Your Payments Is Key

Sure, being able to pay back a loan in only two weeks sounds great. But if the payment for that loan is too big for you to handle, you could enter a dangerous cycle of debt.

If you’re considering a bad credit loan, what you’re probably picturing is a short-term payday loan. After all, the interest rates might be high, but you’ll have the loan paid off in two weeks! Sounds like the perfect solution to your financial needs, right?

Except that it’s not. Or at the very least, it’s a lot more complicated than that.

If you’ve never considered taking out a bad credit installment loan over a short-term payday loan, you should. After all, when it comes to bad credit borrowing, finding a loan with payments that you can actually afford is going to be key.

Short-term loans versus long-term loans.

Unfortunately, a lousy credit score means that you’re pretty much locked out from traditional personal loans. Instead, you’re going to have to settle for bad credit loans, which fall into two camps. The first camp is short-term loans like payday loans or title loans, and the second is long-term installment loans.

With short-term loans, you’ll usually only get around two weeks to a month to pay back your loan, and interest will be charged as a flat rate. So if you borrowed $300 with a typical payday loan, you’d be charged $15 per $100 borrowed and you’d get two weeks to pay back $345, often through an automatic debit or a post-dated check.

With a long-term bad credit installment loan, you’ll typically have a loan repayment term between 6 months and a couple years, and you’ll often be able to borrow more money than you could with a payday loan. Typical terms might be $1,000 for 12 months with a 120 percent interest rate.

Going only by those numbers, it would seem like a short-term payday loan is the way to go, but appearances can be deceiving.

Larger payments are harder to afford.

Let’s return to the two loans from the above example.

With the payday loan, you would have two weeks to make one payment of $345 covering your entire loan—$300 of that would be principal and $45 would be interest. With the installment loan, you would instead have monthly payments of $146.76, paying back a total of $1,761.16 over the course of one year.

Here’s the question: Which payment would be easier for you to make? Is it the monthly payment of $146.76 or is it the much larger payment of $345 that comes within two weeks?

This is the tricky thing with short-term bad credit loans like payday loans and cash advances (The two are practically the same thing, by the way). Shorter terms keep costs down on paper, but they produce larger payment amounts that are more difficult for customers to repay.

A study from the Pew Charitable Trusts found that only 14 percent of payday loan borrowers had enough money in their budget to make their payments.

Beware the payday debt cycle.

Those larger payments create a cycle of debt wherein customers are forced to borrow another loan immediately after paying off their previous loan or choose to roll over their first loan—paying only the interest owed and extending the due date in return for more interest.

According to the Consumer Financial Protection Bureau (CFPB), a whopping 80 percent of payday loans are rolled over or reborrowed within 14 days. They have also found that the average payday loan borrower spends 200 days per year in debt and takes out an average of 10 payday loans annually.

Amortization is important too.

As you might have noticed, the amount of interest paid on the installment loan we mentioned above doesn’t seem to quite match up with its stated APR. If you borrowed $1,000 for twelve months at 120 percent APR, shouldn’t you pay back $1,2000 in interest, not $761.16?

Nope! In addition to having smaller, more manageable payments, most bad credit installment loans also come with amortizing interest structures. This means that interest accrues over time instead of being charged as a flat fee. And it also means that your loan accrues less interest over time as you pay down your principal loan amount.

And that’s not all. Every full, on-time payment you make on an amortizing installment loan is guaranteed to pay down your principal loan amount. While your first payment goes mostly towards interest, each subsequent payment pays down a larger and larger portion of the principal. It all goes according to the loan amortization schedule.

Lenders should care about your ability to repay.

You should never take out any loan–no matter the interest rate or the payment term–if you can’t afford to make your payments. With traditional personal loans, this isn’t going to be too much of a problem, as your lender will be pretty good at figuring out what you can and can’t afford before they approve your application.

With bad credit loans, however, things are different. Another name for these types of loans is “no credit check loans” because these lenders don’t perform a hard credit check when processing your application. In fact, some of these lenders won’t do anything to verify if you can afford your loan at all!

And while that might seem tempting, it’s something you should really take as a warning sign. A bad credit lender that doesn’t care about your ability to repay your loan on time might very well be hoping that you can’t. If you have to roll over or reborrow your loan, all that means is more money for them.

There are things that a bad credit lender can do to verify your ability to repay that don’t involve running a hard credit check and dinging your score. Among other things, they could run a soft credit check, get data from an alternative consumer reporting agency, or verify your income.

Affordable payments can be worth some extra cost.

When you get right down to it, a payday loan that is paid off on time will cost you less money than a bad credit installment loan. But borrowing responsibly is about more than how things happen “on paper.” If you’re not taking into account your financial capabilities, then you are setting yourself up for failure.

A payday loan that you can’t actually afford isn’t going to do you any good, while an installment loan that you can afford quite possibly will—especially if the lender reports your payment information to the credit bureaus, which can help your score.

Plus, you could always pay your installment loan off early to save even more money. Just make sure that your lender doesn’t charge prepayment penalties, first.

Minimizing the amount of money you’ll spend towards interest is important. But you have to account for your financial capabilities in the short-term and the long-term. If you end up taking out 10 payday loans and spending two-thirds of the year in debt, all that money you were trying so desperately to save will be gone.

What’s the best way to avoid bad credit loans? Fixing your credit! To learn more about how you can improve your credit score, check out these related posts from OppLoans:

What other questions do you have about borrowing with bad credit? We want to hear from you! You can find us on Facebook and Twitter.

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