Loans typically fall into one of two categories: installment or revolving, depending on how a borrower takes and repays them. Learn more about installment and revolving loans and which category payday loans fall under.
What is an Installment Loan?
When a borrower applies for an installment loan, they borrow a lump sum of money, such as $1,000 or $10,000. Many types of loans are installment loans, such personal loans, student loans and car loans. Mortgages are also examples of installment loans.
People who borrow money with an installment loan pay back the amount over time, usually in equal installments. How long they have to pay back the loan depends on the initial terms. With a 30-year mortgage, a person makes monthly payments over the course of 30 years, for instance. Many installment loans are shorter than 30 years, though. For example, a car loan might be for five years or a personal loan might have a term of three years.
One of the benefits of an installment loan is that the monthly payment remains the same over the term, as long as the loan has a fixed interest rate. If the loan has an adjustable or variable interest rate the payment amount can vary over time.
If the loan has a fixed interest rate and the payment remains the same each month, it can be easy to budget for an installment loan. Borrowers know what they need to pay each month and can plan accordingly. Having a fixed, predictable payment can help people avoid missing payments.
It is possible to pay off an installment loan early, to save money on interest, and to get out of debt sooner. However, some loans charge a pre-payment penalty, meaning a borrower has to pay a fee for the privilege of paying off their debt.
A person’s credit history determines the terms they get on an installment loan. Often, people with lower credit scores get charged higher interest rates. Those higher rates make the cost of the loan go up. It might be in a borrower’s best interest to bring up their credit score before applying for an installment loan.
What is a Revolving Loan?
While installment loans let people borrow a pre-set amount, revolving loans let people borrow money as they need it. Credit cards are the most common examples of revolving loans. Home equity lines of credit are also common.
With a revolving loan, a borrower usually has a credit limit, such as $1,000 or $10,000. They can borrow against that amount, but don’t have to take out all of it. A borrower only has to repay what they borrow. For example, if they have a credit card with a $1,000 limit and they charge $100 worth of purchases to the card, they only need to repay $100.
How much a person borrows against a revolving credit line gets subtracted from the limit. After they pay the amount charged, the limit resets and a person can borrow up to the full amount again. For example, someone charges $100 on a credit card with a $2,000 limit. Once they pay off the $100, they can make a purchase for $2,000. When they pay off that purchase, they can charge more on the card.
Often, revolving loans require a person to make at least a minimum payment on the balance owed monthly. Paying the minimum amount will slowly pay off the loan, as it also includes interest and any fees. People can pay more than the minimum due but less than the full balanced owed, if they prefer. Whatever amount they pay off will get added to their available credit.
For instance, someone who charged $2,000 to a credit card with a $2,000 limit makes a payment of $500. They still owe $1,500 but now have $500 of credit to borrow against again.
As with an installment loan, a person’s credit history affects the interest rate and terms of a revolving loan. It is often possible to avoid paying interest on a revolving loan, though. Paying the full balance due before the end of the grace period means a person doesn’t have to pay interest.
Is a Payday Loan Installment or Revolving?
Which category do payday loans fall into? The answer is neither. A payday loan isn’t a type of installment loan, as the full amount of the loan is typically due all at once. It’s not a revolving loan either, since borrowers can’t repeatedly borrow against and pay back the loan.
Since the full amount of the loan is due at once, people often struggle to repay payday loans, leading to them getting caught in a cycle of debt.
Better Alternatives to Payday Loans
A payday loan can seem like a quick way to get cash when a person needs it. But the loans are expensive. They usually charge high interest rates and are difficult to pay off. If someone needs money ASAP, there are better options out there.
One option is to use a secured credit card. Secured credit cards are designed to help people with low credit scores build up credit. They require a borrower to put down a deposit as collateral. Secured credit cards are examples of revolving loans.
Another option is to apply for a payday alternative loan (PAL). Credit unions offer PALs to people with low credit scores. They usually charge interest rates up to 28%. A PAL is a type of installment loan. Borrowers typically have between one and 12 months to repay what they borrowed.
If you have a payday loan that you are struggling to repay, help is available. DebtHammer goes after predatory lenders to help you smash your debt. Contact us today to get started.