Payday loans are designed for individuals with poor credit or limited credit history. These loans carry extremely high interest rates, and payday lenders often engage in predatory practices. Borrowing at such high interest rates to cover everyday expenses can trap borrowers in a cycle of escalating debt. Despite these issues, industry research firm IBISWorld predicts that the payday loan industry will grow by 5.1 percent this year.
While payday and short-term loans might seem like a quick fix for those in need of fast cash, installment loans are generally a much safer and more affordable alternative in the long run.
Payday loans vs. installment loans
Payday and installment loans both provide short-term solutions for immediate cash needs, but they differ in several key aspects: security, loan amount, and repayment terms.
Payday loans are usually smaller, often a few hundred dollars, and must be repaid in one lump sum by the borrower’s next paycheck. They do not require collateral. In contrast, installment loans can be much larger and are repaid in increments over several months or even years. They may or may not require collateral, depending on the lender’s terms.
While both types of loans carry risks, installment loans are generally considered less risky than payday loans due to their longer repayment periods and potentially lower interest rates.
| 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 often unsecured and do not require collateral. They are typically available in amounts of $500 or less, with interest rates exceeding 400 percent APR in some cases, subject to state regulations.
Repayment of these loans is usually required by the borrower’s next payday, in full. Some states permit lenders to renew the loan if borrowers need more time.
Other types of short-term loans include:
- Car title loans, which use the borrower’s vehicle title as collateral. Typically, repayment is required within 30 days, or the lender may repossess the vehicle.
- Pawn shop loans, where a valuable asset is used as collateral for a loan. Failure to repay results in forfeiture of the asset to the pawnbroker.
Problems with short-term loans
Payday loans provide vital cash assistance to nearly 12 million Americans across 38 states. However, they can wreak havoc on someone’s financial stability for several reasons:
- Direct account access: Payday loans grant lenders direct access to borrowers’ checking accounts. When payments are due, lenders automatically withdraw funds. If the account balance is insufficient, borrowers face overdraft fees from their bank and additional charges from the payday lender.
- Predatory nature: Obtaining a payday loan is often effortless. With minimal requirements such as ID, employment verification, and checking account details, lenders do not typically assess credit scores. This ease of access leads to loans being granted to individuals who may struggle to repay them.
- Cycle of debt: Payday loans can ensnare borrowers in a cycle of debt. For those constantly short on funds, rolling over original loans into new, larger ones under the same fee structure can lead to financial distress due to high interest rates and fees.
- High costs: Payday loans come with exorbitant interest rates and fees, surpassing those of installment loans or credit cards by a significant margin. This expense further burdens borrowers already facing financial challenges.
Installment loans
Installment loans encompass various types of borrowing, such as auto loans and mortgages, where borrowers make monthly payments over a set period. These loans can vary in size from a few hundred dollars to $100,000 and may be secured or unsecured.
Typically, installment loan payments are fixed amounts over a predetermined period, usually spanning several years. While payday loans may carry interest rates exceeding 650 percent, the average interest rate for personal loans stands at 12.20 percent as of May 15, 2024.
Risks of installment loans
However, installment loans also pose certain risks:
- Fees: Some installment loans may incur origination, late, or insufficient fund fees, increasing the overall cost of the loan. It’s essential to compare lenders to find the most cost-effective option.
- Increased debt burden: Taking on additional debt always carries risk. Borrowers must ensure they can comfortably repay the loan to avoid long-term financial strain. However, installment loans may help reduce debt if obtained for debt consolidation purposes.
What you need to apply for a loan
When preparing to apply for an installment loan, gather the following documents and information:
- Loan application: Complete the application either online or in person, depending on the lender. Many online lenders offer a straightforward digital application process.
- Loan purpose: Be ready to disclose the purpose of the loan, which helps lenders determine the loan amount and ensure the funds will be used appropriately.
- Proof of identity: Provide two forms of identification, such as a driver’s license, state-issued ID, passport, Social Security card, or military ID, to verify your identity.
- Employer and income verification: Verify your ability to repay the loan by providing your employer’s contact information and recent pay stubs, tax returns, bank statements, or W-2s/1099s to confirm your income.
- Proof of address: Furnish documents like a mortgage statement, lease agreement, utility bill, property tax receipt, or voter registration card to validate your address.
Additionally, the lender will assess your credit score to determine your creditworthiness and set the loan rate accordingly.
Other alternatives to short-term loans
If you’re seeking alternatives to payday and installment loans, consider these options:
- Credit-builder loans: Tailored for individuals with limited or no credit history, credit-builder loans involve the lender depositing the loan funds into a secured savings account. You gain access to the funds only after successfully completing all installment payments.
- Payday alternative loans (PALs): Offered by credit unions to their members, PALs provide small loans typically below $1,000, with repayment terms spanning from one to several months, depending on the credit union’s policies.
- Request an advance from your employer: Some employers extend paycheck advances to their employees, allowing you to receive a portion of your upcoming paycheck early. Keep in mind that advancing your next paycheck may result in reduced pay during the subsequent pay period.
- Negotiate a payment plan with creditors: Reach out to your creditors, whether for medical bills or credit card debt, and discuss your financial circumstances. They may offer alternative payment plans that suit your current situation and help alleviate financial strain.
In Conclusion
If you’re facing financial hardship or an emergency, there are alternatives to expensive payday loans that offer fast cash. One such option is an installment loan, which typically comes with a more flexible repayment schedule and lower borrowing costs.
Although short-term loans may appear to be the easiest solution to address immediate financial needs, exploring alternative options is advisable. By researching these alternatives, you may discover a solution that is better suited to help you regain financial stability.