Are you considering taking out a fast cash loan? Before you borrow, take a careful look at your options.
Taking on debt is always a calculated risk. Unfortunately, it’s a risk you may have to take if you’re pressed for cash. But not all debt is created equal, and you need to carefully consider all of your options before you commit to one. In the case of an installment loan vs. a payday loan, there’s a clear winner and a clear loser (hint: it rhymes with mayday).
But many borrowers who face that decision make the wrong one, especially when they don’t understand the difference. But if you choose poorly, it can cost you thousands of dollars, ruin your credit, and burden you with debt payments for years to come. So let’s take a look at what makes one so much better than the other.
What is an Installment Loan?
An installment loan grants qualified borrowers a lump sum, then requires that they pay back the full amount plus interest at regular (usually monthly) intervals over a set period.
For example, if you were to take out a $21,000 installment loan to pay for a car, 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, but they’re generally cheaper than credit cards and much cheaper than payday loans, with higher borrowing limits than both.
Installment loans also usually have fixed interest rates, which creates a stable and predictable repayment process. The payback period, or loan term, can be as short as six months (for personal loans) or as long as thirty years (for mortgages).
The form of installment loan that’s most comparable to a payday loan would be a personal loan. To give you context, you can take a look at some examples of rates and borrowing limits for personal loans below.
Secured vs. Unsecured Loans
Installment loans also sometimes require that you pledge something of value as collateral. Collateral is an asset attached to the loan that lenders can seize to protect themselves if a borrower is unable to pay them back.
For example, mortgages almost always list the property they were used to purchase as collateral. If you’re ever unable to make payments on your house, they can foreclose on you and sell it off to recoup their losses. Because secured loans are generally less risky to the lender, they also usually have better terms.
But if you’re concerned that you won’t be able to repay your loan, it might not be worth it to gamble with collateral. Failing to pay back an unsecured loan can hurt your credit, but it can’t cost you your house.
What is a Payday Loan?
Payday loans are more like an expensive cash advance than 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 (generally smaller than that of an installment loan), then pay back the principal plus a large fee when they get their next paycheck. The high interest rates make this a very expensive form of borrowing.
For example, if you were to take out a $500 payday loan to cover your groceries for the month, you might have to pay back $575 in full within just two weeks.
Payday loans don’t require a credit check. In fact, they don’t require much at all. The loan application process is simple: all you typically need to qualify for one is a paycheck, a bank account, and a pulse.
Repayment terms are also quite simple. The money is due from your next paycheck.
They’re usually limited to a few hundred dollars at most and are used to pay for necessary monthly bills when you can’t afford them on your own.
The problems begin with their exorbitant fees, which would amount to something like 400% APR when annualized. Predatory lenders know that most borrowers that approach them have their backs against the wall financially, and they use that to their advantage.
The problems literally compound when you find that you’re unable to repay your first payday loan. You’ll be charged a late fee for missing the payment and probably need to take out a rollover loan to cover it, which will send you spiraling into the payday loan trap.
Installment Loan vs. Payday Loan: The Key Differences
The most important differences between an installment loan and a payday loan are the following:
- Cost to borrow: Installment loans cost somewhere between 3% and 36%, while payday loans can range from 200% and 450%.
- Qualification requirements: Installment loans are only given to borrowers who can be reasonably expected to repay them, while payday loans are designed to catch borrowers who are struggling financially. This means it should be relatively easy for borrowers will good credit to qualify for a lower interest rate, while borrowers with bad credit will have a tougher time meeting the application requirements, and will either be turned down or charged higher interest rates.
- Repayment period: Installment loans spread repayment out over longer terms with a fixed monthly payment, while payday loans require you to pay back the full balance plus excessive interest or fees by your next paycheck.
As you can probably tell, there’s a pretty clear winner in the case of the installment loan vs. the payday loan.
Which One Should You Choose?
The bottom line is that you should do your best to avoid payday loans at all costs. If you can qualify for an installment loan, it’s an almost universally superior option.
Payday loans are just too expensive, and you risk getting stuck in a vicious cycle of debt, even when you try to limit yourself to just one. If you’ve already gotten stuck in the payday loan trap and are looking for ways to get out, Debt Hammer can help you escape. We know how to reduce your loan amounts, simplify your payments, and support you on the way to debt-freedom. Schedule a free consultation with us today to start reducing your payday debt.