Americans are no strangers to installment loans. Over 45 million of us owe a whopping $1.7 trillion in student debt. That number is astronomically higher when you consider the amount of consumer debt we’ve taken on as well.
However, in times like these as we all battle inflation and increased costs of living, sometimes a loan is the only option you have. If that’s the situation you find yourself in and you’re considering a short-term loan, you might be wondering if a payday loan or an installment loan is the better option.
Both loans have their pros and cons, so it can be tricky to decide which one is right for you. In this article, we'll break down the differences between payday and installment loans so you can make an informed decision.
What is a Payday Loan?
A payday loan is a type of short-term borrowing where the borrower uses their next paycheck as collateral. Payday loans are typically for small amounts, usually $500 or less, and have very high interest rates, often 400% APR or more.
This means that if you took out a $500 payday loan, you would need to pay back $2000 just two weeks later. Because of the high costs and risks associated with payday loans, they are generally only used as a last resort when other options have been exhausted.
If you're considering taking out a payday loan, be sure to understand all the terms and conditions before signing any paperwork.
What is an Installment Loan?
An installment loan is a loan in which there are a set number of scheduled payments over time. You will pay the same amount each month, and the loan will be paid off in full at the end of the term.
Installment loans are typically much larger than other types of loans, such as payday loans, and can be used for a variety of purposes, such as buying a car or paying for college tuition.
The term of an installment loan can vary from a few months to several years, and the interest rate is usually fixed, so you know exactly how much you will need to pay each month. Ultimately, this makes these types of loans a good option for those who need a large amount of money and can commit to making regular payments over time.
Payday Loans vs. Installment Loans
When you're faced with unexpected expenses or a tight budget, it can be tempting to turn to a quick loan for financial relief. However, it's important to understand the difference between payday loans and installment loans before you make a decision.
Payday loans are typically small, short-term loans that must be repaid in full on your next payday. On the other hand, installment loans are larger loans that can be repaid over time in a series of installments. Payday loans typically have higher interest rates and fees than installment loans, so they can end up costing you more in the long run.
Installment loans may also have lower interest rates and flexible repayment terms, making them a better option for many borrowers.
Loan Amounts
As mentioned above, payday loans tend to be for smaller amounts around $500 or so. Because of the high interest rates, it simply doesn’t make sense to take out a payday loan for a lot of money.
Installment loans, on the other hand, can be for large amounts up to hundreds of thousands of dollars. A mortgage loan is a great example of this! You can get a mortgage loan for $200,000 and pay that back over 30 years.
This isn’t the case with a payday loan where you’d borrow $500 as a way to access quick cash for an emergency and then pay it back within a couple of weeks.
Credit Checks
The biggest benefit of a payday loan is that most don’t require a credit check. Since they’re using your future paycheck as collateral, there’s no point in running a full credit check. This isn’t the case with an installment loan.
If you apply for a large auto loan, mortgage loan, or any other type of installment loan, the lender will absolutely have to run a credit check. Not only does this mean you need better credit to qualify for an installment loan but it also means that applying for one will incur a hard credit check on your credit report.
APRs
Likewise, when it comes to payday loans vs. installment loans, the biggest benefit that installment loans have is that the APRs are way lower.
Remember, the average APR on a payday loan is anywhere between 300 to sometimes 600%! With an installment loan, you can expect interest rates to hover around 3% to 9% depending on your credit score.
Payday Loans vs. Installment Loans: Which is Best for You?
So, which is right for you? It depends on your personal financial situation.
If you need access to a small amount of quick cash and don’t have great credit then a payday loan might be best for you. Situations in which this might make sense include needing access to a few hundred dollars to pay an important bill, to fund an emergency expense, or to pay rent.
However, if you have decent credit, need a large loan, and are able to make consistent long-term payments then an installment loan is going to be better for you. If your credit is good enough, it makes sense to avoid paying the high interest rates that come with a payday loan if possible.
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