Are you considering taking out a fast cash loan? Before you borrow, take a careful look at your options.
Falling into debt is something that’s never planned, but it is something that everyone needs to watch out for and be prepared for should it happen.
For instance, if you become pressed for cash, whether to buy a new car after your old one has had it or you need to pay an unexpected medical bill, you may have to consider taking out an installment loan or even a payday loan.
But what’s the difference between an installment loan vs. a payday loan? Plenty. A borrower who faces such a decision can easily make the wrong choice, especially when or if they don’t understand the difference. Here’s the difference between the two types of loans to help you decide.
What is an Installment Loan?
An installment loan gives qualified borrowers a lump sum, then requires them to pay back the full amount plus interest at regular (usually monthly) intervals over a set period. These are for a larger amount of money than payday loans.
For example, if you were to finance an installment loan for $2,100 with 159.57% interest, here’s how the repayment schedule might look:
Types of installment loans
Installment loans can be broken down into a half dozen different categories, usually revolving around the purpose of the loan, like:
- Auto loans or car loans
- Student loans
- Personal loans
- Medical bills
The rates and limits for installment loans vary by category and credit score. Still, they’re usually cheaper than credit cards and much more cost-effective than payday loans, with higher borrowing limits than either one.
Installment loans have fixed interest rates, which creates a stable and predictable repayment process. The payback timeframe, or loan term, can be as short as six months (for personal loans) or as long as 30 years (for mortgages).
The installment loan that’s most comparable to a payday loan is a personal loan. Here are some examples:
Secured vs. Unsecured Loans
Installment loans may require that you pledge something valuable as collateral. Collateral is an asset attached to the loan that lenders can seize to protect themselves if a borrower can; pay it back.
For example, mortgages always list the property used to purchase as collateral. If you cannot make payments on your house, the lender can foreclose and sell it to recoup their losses. Because secured loans are less risky to the lender, they often have better terms.
But if you’re concerned you won’t be able to repay your loan, it’s not worth gambling with your collateral choice. Failing to pay back an unsecured loan can damage your credit, but it can’t cost you your home.
What is a Payday Loan?
Think of payday loans as an expensive cash advance instead of a loan.
They’re a short-term loan that’s repaid on the borrower’s next payday, but the convenience comes at a high price — sky-high annual percentage rates.
Borrowers receive a lump sum (usually smaller than an installment loan), then pay back the principal plus a large fee when they get their next paycheck. The high-interest rates make this an extremely expensive way of borrowing.
For example, if you were to take out a $500 payday loan to pay for groceries for a month, you might have to pay back $575 in full within two weeks.
Payday loans don’t require a credit check; they don’t require much at all. The loan application process is easy: to qualify you will need a paycheck and a bank account.
Repayment terms are also simple. The money is due from your next paycheck and is limited to a few hundred dollars. Payday loans are used to pay for necessary monthly bills when you can’t afford to pay them.
Buyer beware, however, as payday lenders charge exorbitant fees, which can amount to 400% APR when annualized. Predatory lenders know most borrowers that go this route are in a financial crisis and often take advantage. More than 90% of borrowers end up regretting their original payday loan.
Other big problems can quickly snowball if you cannot repay your first payday loan. Expect to be charged a late fee for missing the payment and will need to take out a rollover loan to cover it.
Want to learn more about why payday loans are seldom your best option? Check out this video:
Installment Loan vs. Payday Loan: The Key Differences
There are significant differences between a personal installment loan and a payday loan, such as:
- Cost to borrow: Installment loans range between 3% and 36%, while payday loans can range from 200% to 450%.
- Qualification requirements: Installment loans are only given to borrowers who can repay them, while payday loans are created to catch borrowers with financial problems. This means it’s easy for borrowers will good credit to qualify for a lower interest rate. In contrast, borrowers with poor credit will have a harder time meeting the application requirements and will be turned down or charged higher interest rates.
- Repayment period: Installment loans spread repayment over longer terms with a fixed monthly payment. In contrast, payday loans require you to pay back the full balance plus excessive interest or fees by your next paycheck.
In the end, when choosing between an installment loan vs. a payday loan it’s easy to see which is better if you require a loan.
Which One Should You Choose?
Try to avoid payday loans at all costs. If you can qualify for an installment loan, it’s a far better financial solution.
Other Alternatives to Payday Loans and Installment Loans
Payday loans and installment loans are not the only loan options. Other alternative financial services might be more attractive for personal financial needs.
Cash advance apps
These apps charge no origination fee, and you can typically obtain money by the next business day, which can come in handy if you need cash fast and need to pay bills. The payment terms, as well as loan qualifications, are also simple. Many don’t charge interest, instead relying on tips from customers, and some charge a small monthly fee. Dave is one good choice, but there are plenty of other options.
Read more: 10 Best Cash Advance Apps for Instant Money
Home refinancing replaces a current home mortgage loan with a new mortgage loan. A mortgage has two things: the mortgage term or length of time before the loan is paid in full and the interest rate; typically, home refinancing is utilized to change one or both. Rates are low right now, so it could be a good time to tap into your home’s equity. But if you don’t want to go through the time and expense to refinance, there are some other home loan options.
What is a Home Equity Line of Credit (HELOC)?
Opposite a conventional loan, a home equity line of credit is established ahead of time and used when you need it, like a credit card. However, with a HELOC, your home is used as collateral.
A HELOC has a credit limit and a certain borrowing period, which is typically 10 years. During this period, you can go into your line of credit to take out money (up to your credit limit) when needed. You use the money only when you need it and can continue to use the funds while repaying them.
Many HELOCs charge variable interest rates; these rates are part of a benchmark interest rate and can be changed up or down.
During the borrowing period, at least a minimum monthly payment on the amount owed is required. Some HELOCs allow interest-only payments during the borrowing timeframe. Other HELOCs require minimum payments of principal and interest.
Once the borrowing period is completed, you’ll repay the remaining balance on the HELOC, with interest, no different than a regular loan. The repayment period is usually 10 or 20 years. You might be able to convert some or all of the balance owed on a variable-rate HELOC to a fixed-rate loan.
If a HELOC is like a credit card, a home equity loan is like the original home mortgage; borrow a certain amount and make regular payments during a fixed repayment period.
Home equity loans
With a home equity loan, consumers apply for the amount needed, and most charge a fixed interest rate that doesn’t change during the loan period.
And bear in mind each payment is made at the same time every month (if it is a fixed-rate HELOAN) and adds interest charges and a portion of the loan principal.
A home equity loan lets you use the equity you’ve built up in the home as collateral to borrow funds. Like a primary loan used to purchase a house, the home is used as security to protect lenders if there’s a default on the loan. Home equity loans are also known as second mortgages because there’s another loan payment as well as the primary mortgage that needs to be paid.
Credit union Payday Alternative Loans (PALs)
Payday Alternative Loans or PALs are beneficial for borrowers in need of cash for emergency expenses. Plus, the national credit union administration keeps a tally of PAL-I and PAL-II payday loans. The best part, there is a 28% APR rate cap on these types of loans.
The bottom line
Payday loans can be extremely costly, and the repayment terms are also difficult for most borrowers. This combination may find you stuck in a vicious cycle of debt — even if it’s only once you opt for a payday loan.
If you’re already stuck in the payday loan and searching for ways to get out, DebtHammer can help. We know how to reduce your loan amounts, offer support, and find a way toward debt freedom. Schedule a free consultation with us to discuss your options.
In certain cases, you can have more than one loan at a time but ask yourself if you can balance the extra debt. You’re more likely to be cut off from obtaining multiple loans by the lender than the law. Don’t be surprised if a lender limits the number of loans or the total amount of money he/she will give you.
A prepayment penalty is a fee various lenders charge if you pay off all or part of your mortgage or another loan early. If you have a prepayment penalty, you agreed to this in your original loan agreement, or at closing. Keep in mind not all mortgages have a prepayment penalty.
Credit counseling can help a consumer address their money and debt problems by offering advice and providing helpful resources. You can usually get credit counseling via a nonprofit organization, and it involves an analysis of a person’s financials. You should receive a variety of suggestions to resolve the problem.
Federal Trade Commission rules mean you’re entitled to one free copy of your credit report every 12 months from each of the three nationwide credit reporting companies. The credit bureaus are Experian, Equifax and TransUnion. Order each online from the authorized annualcreditreport.com, or call 1-877-322-8228.