Payday Loan vs Installment Loan, Which is Better?
Navigating unanticipated expenses can be a challenge, especially if your financial health isn’t quite where you want it to be. If you find yourself needing some extra cash to make ends meet, you might benefit from taking out a short-term loan.
What is a Payday Loan?
With a payday loan, you get cash upfront, with maturity in just one or two weeks (or on your next “payday,” hence the name). At that time, borrowers are expected to repay the loan in full – although you may be able to extend the maturity date for a fee.
These loans are generally for quite a small amount, often $500 or less. Conversely, fees can be very high. According to the Consumer Financial Protection Bureau, effective interest rates frequently reach nearly 400%.
While loan costs vary by lender, payday loans have a reputation for being a high-interest-rate option. As such, regulation can be strict, with many states effectively banning payday loans altogether.
What is an Installment Loan?
With an installment loan, a borrower repays money in fixed “installments” over a regular time frame, usually each month. When navigating short-term expenses, many people turn to personal installment loans.
A personal loan is an unsecured loan that’s typically repaid over months or years. As of the latest Federal Reserve data, interest rates on personal loans averaged just over 12%. While personal loans don’t necessarily need to be installment loans, this structure is the most popular alternative to payday loans.
Key Differences Between Payday Loans and Installment Loans
Both payday loans and personal installment loans are often used as a form of short-term financing to cover unanticipated expenses. The two are not created equal, and there are significant differences between them.
Installment loans require a credit check
Most installment loans require some form of a credit check (although whether that’s a hard inquiry or soft inquiry will depend on the lender). In contrast, payday loans usually do not require a credit check.
If you have a good credit history, you’ll generally be able to get a much lower interest rate on an installment loan than you would with a payday loan. If your credit history is poor, you may not qualify for an installment loan.
Installment loans are usually unsecured
In lieu of a credit check, most payday lenders will require some proof of stable employment. Similarly, borrowers typically have to provide a postdated check or allow lenders to withdraw funds electronically from their bank account.
That process, when paired with a regular payroll schedule, provides a form of collateral security for the lender. That stands in contrast to personal installment loans, which are usually completely unsecured.
Installment loans require regular payments over a longer timeframe
Both payday loans and installment loans provide you with money upfront, but the repayment schedule differs significantly for each. With a payday loan, you’ll have to pay back the amount in full (plus fees and interest) upon maturity. With an installment loan, you’ll have to make regular, fixed payments for a combination of principal and interest.
Monthly repayment schedules are the most common structure for personal installment loans, which frequently last from 12 to 60 months on average. In contrast, payday loans often come with terms of just a few weeks. You’ll have to be careful, though – many borrowers can take months to pay back a short-term payday loan, racking up high fees and expenses in the process.
Installment loans are made for higher amounts at lower interest rates
Payday loans are frequently made for just a few hundred dollars. The average debt for a personal loan, however, is about $11,000.
This greater funding amount reflects the diversity of uses for personal loans. While they can be used as an alternative to payday loans to bridge unexpected expenses, they are also often used as a form of debt consolidation or for home improvements.
Despite the higher funding amounts for personal installment loans, interest rates are generally significantly lower. This reflects tighter credit qualification restrictions when compared with payday loans.
Pros and Cons of Payday Loans and Installment Loans
Both payday loans and installment loans have their benefits, and the right choice is highly dependent on a borrower’s financial situation. To understand the tradeoffs of each, let’s compare the pros and cons of each loan type in comparison with each other.
Payday loans pros and cons
- Quick repayment timelines. Many payday loans set repayment terms at just a few weeks. If you can make the necessary payments, you can be out of debt quite quickly.
- Looser qualification requirements. Since credit checks are rarely required for a payday loan, it’s much easier to qualify. Still, you’ll usually have to provide proof of employment.
- Flexible rollover options. It’s not uncommon for a borrower to need some extra time to repay a payday loan, so lenders can be more flexible. Be advised, though, that this can lead to the accumulation of high fees.
- High rates and fees. Payday loans usually come with significantly higher interest rates than installment loans.
- Lack of credit reporting. It’s uncommon for payday lenders to report payments to any credit bureaus, which can make building credit challenging.
- Challenging repayments. Payday loans have a default rate of nearly 20%, indicating that many borrowers have trouble effectively budgeting for the necessary repayments. Since lenders often have direct access to your bank account, you may not have a say in when repayment is withdrawn, which can lead to overdraft fees.
Installment loans pros and cons
- Lower interest rates. Although installment loan interest rates may be higher than mortgages or car loans, they’re usually significantly lower than payday loans.
- Higher funding amounts. If you’re looking at an installment loan as a payday loan alternative, you may not need a high funding amount – but it’s nice to have this flexibility, just in case.
- Regular payments. Installment loans come with fixed payments, usually made monthly. This makes it significantly easier to budget for debt payments, helping you stay financially healthy. Further, such payments are often reported to credit bureaus, which can help you build credit.
- Tighter qualification requirements. Installment loans usually need a credit check, which can make them more challenging to qualify for.
- Longer repayment timelines. It can be frustrating to be in debt for a long time, and installment loans can take years to successfully pay off.
- Limited rollover options. Because lenders expect you to repay installment loans in a fixed timeframe, there are often limited options to extend this timeline or “rollover” the loan. If your situation changes, this can make it more challenging to navigate debt payments.
Which Loan Should You Choose?
If you can qualify for a personal installment loan, it’s likely to be a better option than a payday loan. Since interest rates are much lower and payments are made on a fixed schedule, it’s easier to budget for such loans and maintain good financial health.
If you are unable to qualify for an installment loan, though, payday loans can still be used wisely. Since they often come with higher rates and fees, it’s important that you have a very thorough understanding of the loan terms and repayment timelines in order to pay the loan off quickly.
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