If you need cash quickly, you might spend hours scouring the internet to find out if a payday loan or a short-term installment loan is the right product for your needs. This article aims to help answer that question.
The first step is an explanation of both products.
The Consumer Financial Protection Bureau (CFPB) describes payday loans as follows:
Payday loans are typically described as a way to bridge a cash flow shortage between paychecks or other income. Also known as “cash advances” or “check loans,” they are usually expensive, small-dollar loans, of generally $500 or less. They can offer quick and easy accessibility, especially for consumers who may not qualify for other credit.
Originating in the 1990s, payday loans can be obtained in retail locations or through online companies. Because payday loans are unsecured and typically marketed to those with poor credit or no credit, interest rates are high. Repayment is due in one lump sum, typically after the borrower’s next pay day, in the form of a post-dated check or an automatic withdrawal from the borrower’s bank account.
Easy – Payday loans are very easy to obtain, with little to no qualifiers other than a steady source of income.
Fast – Cash can be obtained within minutes of completing an application.
Convenient – With local and online options, no credit checks, and no need for collateral, payday loans can be a very convenient option.
Expensive – Payday loans are very expensive and should only be used when the consumer cannot wait or does not qualify for traditional financing.
Availability – Payday loans are illegal in some states.
Debt Cycle – The very short repayment term on payday loans may lead to a debt cycle for many borrowers. The debt cycle begins when the borrower in unable to payoff their loan by the due date and instead does a “rollover” of the debt into a new loan, with new fees and additional interest. The CFPB reported that “more than 80 percent of payday loans are rolled over or renewed within two weeks.”
Traditional installment loans have a much longer history, and most consumers are familiar with the concept, having made payments on a home or automobile, typical examples of installment loan purchases.
Short-term installment loans can range from several hundred to thousands of dollars and are repaid over a matter of months, not years. It would be unusual for a short-term loan to require collateral.
While both payday loans and short-term installment loans are expensive forms of borrowing, installment loans are typically less expensive. Additionally, they also provide a longer repayment period, and feature a fixed interest rate with predictable, scheduled payments. Short-term installment loans are marketed to consumers with a range of credit ratings.
Longer Terms – Unlike a payday loan, a short-term installment loan is repaid over months, not weeks, decreasing the probability of the consumer falling into the debt cycle mentioned above.
Predictable payments – Because of the fixed interest rate, scheduled payments are the same amount and are determined when the loan is secured. Consumers know exactly when and how much their payments will be, allowing them to plan accordingly.
Fast – With the rise of alternative online lenders, consumers can secure a short-term installment loan and have funds deposited in their bank account in as little as 24 hours.
Easy – While the process varies from lender to lender, short-term installment loans are far easier to obtain than traditional loans. Consumers can complete an online application or apply over the phone.
High-Interest – Short-term installment loans typically have higher APRs than traditional installment loans because no collateral is required and lower credit scores are accepted. However, rates are lower than those on payday loans and can be mitigated by paying the balance off early. When considering a short-term installment loan, consumers should verify their lender does not charge a prepayment penalty.
Fees for late/missed payments – As with any financial product, consumers need to know in advance what fees or penalties will be charged for late or missed payments. These fees can be avoided by setting up autopayments through your bank or with your lender.
Now that you have an overview of payday and short-term loans, how can you determine which loan is right for you?
Will you be able to make your payments on time?
The first question to ask yourself, and be completely honest, is how likely is it that you’ll be able to payoff your loan on time? If there’s any doubt whatsoever that you wouldn’t be able to repay a payday loan by your next pay period, it’s not worth the risk. Considering the CFPB report mentioned above, there’s only a 20% likelihood that any payday customer will avoid the debt cycle trap.
What shape is your credit in?
If you can qualify for a short-term installment loan, it’s definitely the less expensive, less risky option. Additionally, paying off the loan on time can improve your credit rating. However, if you can’t qualify for a short-term installment loan, and a payday loan is your only option, make sure you do all you can to pay it off on time. While paying off a payday loan doesn’t typically improve your credit rating, failing to pay it off can hurt your credit – and send you into a debt cycle.
How much money do you need?
Payday loans typically range from $100 - $1,500 dollars, while short-term installment loans can be taken out for thousands of dollars, depending on the borrower’s credit. If you only need a small amount of money and are absolutely positive you can cover it with your next paycheck, a payday loan may be all you need. If you require more funds and more time to repay the loan, stick with an installment loan.