Luis Alvarez/Getty Images
Payday loans are designed for people with bad credit or little credit history. These loans come with sky-high interest rates and payday lenders can be predatory. Taking out high interest loans to cover everyday expenses often launches borrowers into a cycle of deeper debt. Despite this, IBISWorld, an industry research firm, predicts that the payday loan industry will grow 5.1 percent this year.
Payday loans and short-term loans may seem like the solution for people who need fast cash. However, installment loans are generally much safer and much less expensive in the long run.
Payday loans vs. installment loans
Payday and installment loans are similar because they offer a short-term solution when you need cash immediately. The main differences between payday loans and installment loans are whether they’re secured (meaning if collateral is needed to secure the loan), the amount you can borrow, and how long you’re given to repay the loan, plus interest and fees.
Payday loans are typically smaller, like a few hundred dollars, while installment loans can go much higher. Payday loans are also repaid in one lump sum by the borrower’s next paycheck period. Conversely, installment payments are paid off in increments over multiple months or years.
Both types of loans have risks, but generally, installment loans are far less risky than payday loans.
| Payday loans | Installment loans | |
|---|---|---|
| Collateral requirement | Secured and require collateral | Unsecured and do not require collateral |
| Loan amount | Typically $500 or less | Up to $100,000 |
| Repayment terms | One lump sum on your next payday | Paid over several months or years |
| Interest and fees | Up to 400 percent and varies by your state of residence | Lower than payday loans but varies by your credit score |
Payday and short-term loans
Payday and short-term loans are usually unsecured and don’t require collateral. They typically are offered in amounts of $500 or less at interest rates of 400 percent APR or more, depending on your state’s regulations.
These loans must be repaid by the borrower’s next payroll period in full. Some states allow lenders to renew the loan if borrowers need more time.
Other types of short-term loans include:
- Car title loans. Car title loans use your car’s title or “pink slip” as collateral for a short-term loan. Typically, you’re given 30 days to repay the loan in full; otherwise, the lender will take possession of your vehicle.
- Pawn shop loans. These loans require using a valuable asset as collateral in exchange for a small portion of its resale value. If you fail to repay the loan, the pawnbroker keeps your asset.
Problems with short-term loans
Payday loans supply cash to nearly 12 million Americans in need and make credit available to Americans in 38 states. However, those loans can be devastating to someone’s finances for a few reasons:
- Payday loans allow lenders direct access to checking accounts. When payments are due, the lender automatically withdraws the payment from the borrower’s account. However, should an account balance be too low to cover the withdrawal, consumers will face an overdraft fee from their bank and an additional fee from the payday lender.
- Payday loans tend to be predatory. Obtaining a payday loan is easy. Borrowers only need to present ID, employment verification and checking account information. Payday lenders don’t review credit scores, which means they’re too often granted to individuals who cannot afford to repay them.
- Payday loans tend to trap people in a cycle. People constantly strapped for cash can fall into a cycle of payday loans. When original loans are rolled over into new, larger loans under the same fee schedule, borrowers fall into trouble because of high interest and fees.
- Payday loans are expensive. Interest and fees on payday loans are much, much higher than for installment loans or even credit cards.
Installment loans
Installment loans are a common type of loan. They are any kind of loan that you make monthly payments for, including auto loans and mortgages. These loans can range from a few hundred dollars to $100,000 and can be secured or unsecured.
Installment loan payments are a set amount for a set time, usually a few years. Payday loans can have up to 400% interest rates, but the average personal loan interest rate is 12.10 percent as of March 13, 2024.
Risks of installment loans
All types of borrowing come with risk, including installment loans:
- Installment loans can come with fees. Origination, late and insufficient fund fees can make the loan more expensive. Make sure to compare installment loan lenders to find the lowest-cost option.
- Installment loans can add to your debt. Taking on more debt is nearly always risky. You need to make sure you can repay the loan so it doesn’t cause long-term financial difficulties. However, installment loans may be able to reduce your debt if you get one for debt consolidation.
What you need to apply for a loan
When you’re ready to apply for an installment loan, here’s what you’ll need:
- Loan application: If you’re applying with a bank or credit union, the application can generally be completed online or in person. Most online lenders offer a streamlined digital application process.
- Loan purpose: You could also be asked to provide your intended loan use. This helps lenders come up with a loan amount and confirm you plan to use the proceeds for a permissible purpose.
- Proof of identity: Prepare to submit two forms of identification to prove your identity. This includes a copy of your driver’s license or state-issued ID, military ID, passport, Social Security card or certificate of citizenship.
- Employer and income verification: The lender will also need to confirm you can afford to make loan payments. Beyond your employer’s contact information, the lender will also request recent pay stubs, tax returns, bank statements, W-2s or 1099s to verify your income.
- Proof of address: It’s not uncommon for lenders to request proof of address, which could include a copy of your monthly mortgage statement or lease agreement, utility bill, property tax receipt, voter registration card, home or auto insurance statement, credit card statement or bank statement.
The lender will also check your credit score to determine if you’re a creditworthy borrower, and if so, decide on the rate you’ll receive.
Other alternatives to short-term loans
If you need funds, there are alternatives to payday and installment loans. Here are some options:
- Credit-builder loans. These loans are designed for borrowers with low or no credit. The financial institution will disburse credit-builder funds into a locked savings account which you’ll only get access to after fulfilling all installment payments toward the loan.
- Payday alternative loans. Payday Alternative Loans, or PALs, are provided by credit unions for their members. These loans are for a small amount below $1,000 which are repaid over a month or a few months, depending on the institution.
- Ask your employer for an advance. Some employers offer paycheck advances to their employees. Remember, if you advance a portion of your next paycheck, your next pay period will be at a reduced amount.
- Negotiate a payment plan with creditors. Contact your creditors, whether for hospital bills or a credit card bill, to explain your financial situation. They might be able to share payment plan options you weren’t aware of.
Bottom line
An expensive payday loan isn’t your only option to get fast cash if you’re experiencing financial hardship or an emergency. You could also be eligible for an installment loan with a more flexible repayment schedule and lower borrowing costs.
While short-term loans often seem like the most simple solution to resolve your financial woes, it’s worthwhile to research other options. You could find that one of these alternatives is best to help get your finances back on track.
Read the full article here
