If you’re in need of emergency funding, you might find yourself searching the internet for websites offering quick cash. Many of the sites you’ll find will offer payday loans, while others will offer short-term installment loans. This article aims to help you understand the differences between the two and help you decide which is the right product for your financial situation.
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."
Payday loans began in the 1990s and can be obtained either online or through retail locations. Interest rates are high because payday loans do not require collateral and are typically marketed to consumers with poor credit or no credit. The repayment term on a payday loan is very short, usually taking place after the borrower’s next pay day. Payment is typically made in a single lump sum in the form of a post-dated check or an automatic withdrawal from the consumer’s bank account.
Easy – With little to no requirements other than a steady source of income, payday loans are very easy to obtain.
Fast – Funding can be obtained within minutes of completing an application.
Convenient – Because payday loans can be obtained online or through local retailers and don’t require collateral or credit checks, they can be a very convenient financial product for some borrowers.
Expensive – Payday loans are a very expensive form of financing and should only be used when short-term, emergency funding is needed. Payday loans should not be used when traditional financing is an option.
Availability – Payday loans are illegal in some states.
Debt Cycle – Because payday loans have a very short repayment term, many borrowers fail to repay their loan on time, putting them into a “debt cycle.” The debt cycle begins when the borrower misses their due date, and their debt does a “rollover” into a new loan, with additional interest and new fees. 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.
Unlike a loan for a home or vehicle, a short-term installment loan is repaid over a matter of months, not years, and it can range from several hundred to thousands of dollars. Short-term installment loans typically do not require collateral.
While both payday loans and short-term installment loans serve unbanked and underbanked consumers and are, therefore, more expensive forms of borrowing, installment loans are typically less expensive. Short-term installment loans provide longer repayment periods with a fixed interest rate and predictable, scheduled payments.
Longer Terms – A short-term installment loan is repaid over a period of months, not weeks, decreasing the probability of the borrower getting trapped in a debt cycle.
Predictable payments – Borrowers know exactly when and how much their short-term installment loan payments will be because they have a fixed interest rate and payment amounts and dates are determined when the loan is secured.
Fast – Consumers can secure an online short-term installment loan and have funds deposited in their bank account in as little as 24 hours after their application has been approved and processed.
Easy – While the process varies from lender to lender, short-term installment loans are far easier to obtain than traditional loans. Borrowers can complete an online application within a matter of minutes.
High-Interest – Because short-term installment loans typically don’t require collateral while also accepting lower credit scores, interest rates are high. Although rates are lower than payday loans, short-term installment loans should still only be used for emergency funding when traditional financing is not an option due to time constraints or credit history. Whenever possible, borrowers should pay off their short-term loan as quickly as possible to mitigate costs. When considering lenders, be sure to verify they do not charge any early pay-off penalties or fees.
Fees for late/missed payments – As with any financial product, borrowers should know in advance what fees or penalties will be charged for late or missed payments. These fees can be avoided by setting up automated payments 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 your financial situation?
Will you be able to make your payments on time?
If you have any doubt you’d be able to repay a payday loan by your next pay period, the safest bet is to pass. According to the CFPB report mentioned above, there’s only a 20% likelihood that any payday customer will pay their loan back on time and avoid the debt cycle trap.
How Good is Your Credit?
If you have the requirements needed to get approved for a short-term installment loan, it’s the less expensive, less risky option. Paying it off on time and in full can also help improve your credit rating. However, if you don’t qualify for a short-term loan and a payday loan is your only option, make sure you avoid the debt cycle by paying back your loan on time. Although paying off a payday loan won’t go toward improving your credit score, failing to pay it off can have a negative impact.
How Much Money Do You Need?
Payday loans are usually for smaller amounts, from $100-$1,500, while short-term installment loans can be taken out for thousands of dollars, depending on the borrower’s creditworthiness. If you only need a small loan and are absolutely certain you can repay it on time, a payday loan may be all you need. For larger loans you can pay back over a matter of months, stick with a short-term installment loan.