Installment Loans vs Payday Loans: Which to Choose?

payday loan vs installment loan

Unfortunately, many people do not understand the difference between installment and payday loans and cannot determine which financial instrument is better to choose in their circumstances. 

We can all find ourselves in a situation where we need urgent money and don’t have time to analyze our options. That’s why, in this article, we’ve covered all the questions that can help you make the right choice in an emergency: 

  • What are payday and installment loans, and for what purposes can you use them?
  • What to do if you have a bad credit history and need money urgently?
  • Which loan to use for a student loan and which one to use for paying medical fees?

In general, both installment and payday loans are short-term credits, but there are a few distinctive features between them, which we are now going to analyze.

Installment Loans

Imagine you want to buy a phone because yours is broken, but you don’t have enough money for it. Then, you realize you have a steady income but can’t give away $1,000 at a time. What will you do? 

The ideal solution to this problem would be to buy the phone and use it now, but pay later – for example, monthly. That way, instead of $1,000 at a time, you’d give $200 plus a small interest of about $5-20 a month and keep it that way for five months. 

Is this possible? 

Yes! And this is what is called an installment loan. This is the type of loan stores offer you when they use the “buy now, pay later” offer. 

It is a short-term loan that can be used for everyday purposes, often not exceeding the amount of $1,000. However, it can also be a long-term loan used, for example, to buy a car – then the amount rises from $1,000 to $100,000, and repayment terms typically become two to seven years.

Your credit score is the biggest problem when you want an installment loan. The higher the amount and the lower the interest rate, the higher your loan profile should be. 

To summarize: 

  • Installment loans amounts: up to $2,000 for short-term loans and up to the value of a house for longer-term loans.
  • Loan terms: several weeks to a few months for small loans, up to 30 years if you choose a mortgage.
  • The cost of borrowing depends entirely on your credit history. Some lenders charge 2-3%, and some ask for 100%. Experts believe the maximum interest rate for installment loans should be no more than 36% to make them affordable.
  • Credit check: yes, applying for installment loans will require a strenuous review of your accounts.

Pros and Cons of Installment Loans

Installment loans can be a smart solution because of:

  • Fixed, often the same monthly payments;
  • The opportunity to repay early;
  • Easy application;
  • The possibility of getting considerable amounts of money;
  • Affordable interests on the loan.

In some situations, it’s better not to use installment loans because: 

  • Applying requires a hard credit history check – your interest rate and other loan terms are based mainly on your history;
  • The longer you compensate your installment loan, the more interest you pay;
  • You must go to the bank to get the money, which means you must provide all the documents: proof of income, social security number, and personal banking information.

Payday Loans

Typically, a payday loan is chosen by people who have been denied obtaining installment loans. Most often, this happens if a person cannot prove his capacity to pay or if he has loan history problems. 

Payday loan lenders are more tolerant of risk and willing to give money to many of those who banks have turned down. However, they put a much higher price on their loans for the increased risk. This is why the rates on the payday loan agreement are much higher, and the repayment period is shorter. 

Imagine that your car breaks down, and you urgently need to borrow $300. You understand that you can refund it in a couple of weeks with your first paycheck, but none of your friends or family can lend you that much right now. So in this situation, a payday loan can be a suitable option. 

To summarize:

  • Loan amounts: a few hundred dollars on average, but not more than $1,500.
  • Loan terms: these loans can be paid back in a few weeks or once you get your next paycheck.
  • Cost of borrowing: this fee ranges from $10 to $30 for every $100 borrowed.
  • A credit check isn’t required.

Pros and Cons of Payday Loans

The advantages of such loans are these: 

  • They are easy to apply for; the whole process can take a couple of hours to a few days.
  • You don’t need to stand in lines at the bank or provide additional documents.
  • They don’t require a credit history check.

At the same time, the disadvantages of a payday loan may be:

  • The interest rates are incredibly high – around 400% APR on average
  • If you do not repay your loan on time, you will have huge penalties and fees, making it even harder to repay.

Which is Better: Payday Loan or Installment Loan?

To understand which option is best for you, answer the following questions: 

  • Do you have a good credit history?
  • Do you need more than $1,000?
  • Do you have a steady monthly income that will allow you to repay the loan for months or even years?
  • Are you willing to provide documents, such as proof of income, to get a loan?
  • Do you have the possibility to secure the loan with collateral?

If your answer is “yes” to all these questions, installment loans are the right choice. However, if any of these points do not work for you, you can choose a payday loan because it is easier to get and doesn’t require additional documents or a loan history check. 

However, this is a costly loan, and you pay on average $15 every two weeks. So if you can qualify for an installment loan, you’d better choose it. 

Pay attention to the fact that Installment loans may be either secured or unsecured, depending on your loan history, the terms of the lender, and the loan amount. The more money you want, the higher the chance you will need to secure the loan. The loans are collateralized with the object purchased when you buy a house or a car.

This means that under the deed of agreement, the car or house becomes yours only when the entire loan amount has been paid off, and if you cannot repay the loan, the purchased object becomes the property of the lender without returning any money you have paid back. 

What Are the Risks of Short-Term Loans?

Short-term loans are safe only when you repay them on time. If something goes wrong, many problems will occur.

First, your credit history will be negatively affected if you miss a payment or don’t repay the loan in time. This means you will not be able to get a loan for a long time after the incident.

Secondly, these loans are usually taken out by people who have some kind of problem. Colossal interest rates and extra fees only exacerbate the already complex situation, and you can end up in what is known as a debt trap. 

Third, you need to read the contract with the lender very carefully, as not all of them are honest. Be sure to notice all hidden fees or penalties and verify if you can repay the loan earlier. 

Think twice before taking a short-term loan; if you have at least a slight possibility not to take it, use it. 

Alternatives to Short-Term Loans

If you need emergency cash urgently and are looking for alternatives to short-term loans, consider these options: 

A Local Bank Or Credit Union

If you are a member, contact a representative, explain your situation, and see if you qualify for a personal loan. Usually, local banks give their members much better terms, including loans with no origination fees and 5% APR.

Borrow From Family Or Friends

Of course, they seldom can give you large sums, but they certainly won’t ask for 400% APR. If you are in a challenging situation and realize that you may not get the cash back on time, tell them about it immediately, so you don’t ruin your relationship.  

Emergency Loans

Emergency loans are used to compensate for urgent bills, as the funds appear on your account the same day. Lenders usually charge 6 to 36 percent in interest for an emergency loan. The only problem is that this type of loan requires a loan check. 

Apps Cash Advance

This option is very similar to a payday loan because the conditions for receiving cash, in this case, are minimal. All you need to provide is a stable paycheck, a checking account with direct deposit, and a way to verify employment. However, the interest on such a loan can also be enormous. 

FAQ

Is a payday loan secured or unsecured debt?

A payday loan is an unsecured debt, meaning they don’t require collateral, such as a car or home, for approval. However, you have to know that your next paycheck often guarantees your payday loan. 

Does a payday loan require collateral?

No, it doesn’t, though you are still charged interest and sometimes fees for getting a payday loan.

Is an installment loan revolving?

Installment credit is a fixed amount of cash, given to you only if you are to repay it by fixed and scheduled payments. It won’t allow you to borrow the money, spend it and then borrow again as needed; it’s a one-time possibility. 

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