When it comes to borrowing money, there are various options available, but two of the most common choices are payday loans and installment loans. These financial tools serve different purposes and come with distinct features, so it’s essential to understand their differences before making a decision. In this article, we’ll explore the disparities between payday loans and installment loans, helping you make an informed choice based on your financial needs.
Payday Loans: Swift but Expensive
Payday loans are small, short-term loans designed to be repaid within two to four weeks after borrowing. One of the key characteristics of payday loans is that they don’t require a credit check or an in-depth review of your ability to repay the loan. This makes them accessible and quick to obtain. However, it comes at a price.
Payday loans typically involve high fees, ranging from $10 to $30 for every $100 borrowed. These fees translate into high annual percentage rates (APRs). The combination of high costs and short repayment terms can make payday loans challenging to repay, often trapping borrowers in a cycle of borrowing to repay the previous loan.
Installment Loans: Larger Sums with Extended Repayment
In contrast to payday loans, installment loans offer larger loan amounts, sometimes reaching up to $100,000. These loans come with extended repayment periods, spanning months or even years, rather than weeks.
One notable difference is the more thorough evaluation process associated with installment loans. Lenders often check your credit and assess your ability to repay before approving the loan. This means you’ll need a consistent income and at least fair credit (a score of 630 or higher) to qualify for most personal installment loans with APRs below 36%.
How Payday Loans Work
Payday loans can be obtained online or from physical storefront lenders in states where they are allowed. Once approved, borrowers typically receive the funds on the same day or the next business day.
When you secure a payday loan, you’ll be required to sign a contract detailing the loan’s APR and repayment terms. On the due date, the lender will deduct the repayment amount from the account where your income is deposited, or you can repay the loan in person.
Payday Loan Requirements
To qualify for a payday loan, you typically need:
- An active bank, credit union, or prepaid card account.
- Proof of income.
- To be at least 18 years old.
Key Facts About Payday Loans
- Payday loans can be challenging to repay, potentially becoming a significant portion of a borrower’s income.
- They are popular due to their speed and accessibility, with most borrowers being approved regardless of their credit history or income.
- Payday loan fees are high to compensate for the lack of credit checks.
- While payday lenders don’t report to credit bureaus, they do report unpaid loans to collections, which can negatively impact your credit score.
How Installment Loans Work
Personal installment loans can be obtained from banks, credit unions, or online lenders. Many lenders offer the option to pre-qualify online with a soft credit check, allowing you to assess potential loan amounts, rates, and repayment terms without affecting your credit score.
Once you apply and are approved, you’ll sign a contract specifying the APR and repayment terms. It typically takes a day or two for the lender to disburse the loan funds.
Repayment for installment loans typically begins 30 days after you sign the loan agreement, and most lenders establish a monthly repayment schedule.
Installment Loan Requirements
To qualify for an installment loan, you typically need:
- A credit score above 550, with higher scores improving your chances of approval.
- A debt-to-income ratio below 50% and enough income to meet your monthly debt payments and repay the new loan.
- U.S. residency and a minimum age of 18.
Key Facts About Installment Loans
- Installment loans often come with extended repayment terms, resulting in lower monthly payments but higher total interest costs.
- Lenders typically prefer borrowers with good credit, stable income, and a history of on-time payments.
- Timely installment loan payments can help improve your credit score, potentially qualifying you for lower rates on future loans or credit cards.
High-Cost Installment Loans: A Blend of Payday Loans and Traditional Loans
High-cost installment loans occupy a unique space between payday loans and traditional personal loans. They are often offered by online lenders in amounts ranging from $1,000 to $10,000, with repayment terms spanning from nine months to five years. Triple-digit APRs are common with these loans.
Some high-cost installment lenders conduct hard credit checks, while others perform soft checks or none at all. If borrowers are unable to make payments, lenders may offer to refinance the loan, which can increase the total interest costs.
Before applying for any loan, it’s essential to consider alternatives that can help you navigate financial challenges without incurring debt. Here are a few options:
- For essential needs, seek assistance from local nonprofits, charities, or religious organizations to access food, clothing, and transportation for job interviews or medical appointments.
- If you’re struggling with rent, bills, or utilities, contact your landlord, utility company, credit card issuer, or mortgage lender to discuss payment deferrals or set up a payment plan.
- If you’re facing medical bills, explore options like negotiating with the provider’s office, requesting a hardship plan, or setting up a payment plan to manage your expenses.
Understanding the differences between payday loans and installment loans is crucial when making financial decisions. Each type of loan serves specific purposes, and choosing the right one can have a significant impact on your financial well-being.