If you’ve ever been in need of a short-term personal loan, you may have found yourself with two primary options: payday loans and installment loans. Every loan is a serious financial responsibility, so it’s important to understand the differences between the two and choose the best for your situation. Let’s look at how the two compare by starting with their definitions and how they’re generally used.
What is an installment loan?
An installment loan is a lump sum of money issued up front by a lender that a borrower repays in “installments” over a specified period of time (known as the “term”). They are often used to cover larger expenses and financial needs.
What is a payday loan?
A payday loan is a short-term, high-interest loan that is generally due on the borrower’s next payday. They typically provide less money than an installment loan and are used to cover urgent emergency expenses.
What’s the difference between a payday loan and an installment loan?
Payday loans and installment loans are often compared because they are both used to cover personal expenses. They differ, however, in the loan amounts they provide, how they’re repaid and the interest rates they charge.
- Installment loans can range from a few hundred dollars to tens of thousands of dollars.
- Payday loans are almost always for amounts of a few hundred dollars or less.
Bottom Line: Installment loans typically provide more money than a payday loan.
- Installment loans are typically repaid over a few months to several years. The cost of the loan is broken into “installments.” Because payments are broken up, it can make repaying the loan more manageable. Interest and fees are typically broken up too. This means you will make more payments than with a payday loan, but the amount you owe for each payment is smaller.
- Payday loans are very short-term loans. They are typically repaid in full, along with interest and fees, in two to four weeks. This means you’ll only make one payment, but the amount you owe for that payment will be much larger than the individual payments you would make with an installment loan.
Bottom Line: Installment loans break up the cost of the loan over time. Payday loans require full repayment in a lump sum that’s typically due in a month or less.
Interest and Fees
- Installment loans come with a wide range of interest rates that depend primarily on your credit score. Compared to payday loans, however, installment loans typically offer lower APRs.
- Payday loans are known to have very high APRs. The actual interest charged, however, may be lower than that since APR measures the cost of a loan over a year and payday loans are typically due in just a few weeks. If the loan is rolled over, the interest borrowers owe increases.
Bottom Line: Installment loans typically have lower APRs. However, the total cost of interest can still be high depending on the rate charged and how long you take to repay.
Which is better: an installment loan or or a payday loan?
People tend to ask whether one funding type is better than another, but what it comes down to is which funding type is best for each borrower’s situation. Let’s take a look at situations where each of these funding types might work best.
Installment loans are best used for larger one-time purchases such as car repairs, home repairs or debt consolidation. They are better than payday loans when you need a higher loan amount or more time to repay.
Payday loans can be used to cover some of the same expenses as installment loans. However, they will most often be the more expensive option. Payday loans should only be considered when you have an urgent emergency expense and can’t get money from any other source.
What are the pros and cons of installment loans and payday loans?
All loans carry a cost and the risk that you won’t be to repay them. Any time you apply for a loan, you should make sure that the benefits will be outweighed by the risks.
Pros of Installment Loans
- Access to larger amounts of money, especially for those with good credit
- Flexibility with choice of repayment term
- Fixed, regularly scheduled payments in most situations
- Smaller individual payments
- Some lenders may let you repay early to save on interest
Cons of Installment Loans
- Longer loan terms can lead to paying more in total interest than if repaid quickly
Pros of Payday Loans
- Fast funds
- Applying will generally not impact your credit score
- Can provide emergency funds to those not approved for traditional loans
Cons of Payday Loans
- Very expensive form of consumer funding
- Short repayment terms can make it hard for borrowers to pay on time
- Combination of the above two factors can create a debt cycle
Are payday loans and installment loans secured or unsecured?
The terms “secured” or “unsecured” are used in lending in reference to whether or not collateral is required. Both payday loans and personal installment loans are commonly unsecured.
Unsecured loans let you borrow money without putting anything up for collateral. That said, the borrower will typically be charged a higher interest rate to account for the risk the lender takes on by not “securing” the loan.
With a secured installment loan, the collateral will vary depending on the lender. When a bank is the lender, they may use a savings account or certificate of deposit as collateral. For homeowners, a home equity loan could be a type of longer-term secured installment loan option.