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Installment vs Payday loans

Installment vs Payday loans

Personal loans come in many different types and this may create a bit of confusion for the common person when it comes to choosing the type of personal loan. The need of the borrower, in most of the cases dictates the type of loan that a borrower will go for. However even then, there are certain factors that may create some confusion when it comes to choosing the right type of loan.

Installment and Payday loans are two such types of personal loans that are easily available and therefore may put many a borrower into confusion at times. In this article therefore we shall try to understand these two loan types and try to understand their similarities and differences.

What is an installment loan?

It is a type of loan that has to be paid back in monthly installments. The monthly installments comprise of principal and interest repayment. Installment loans can have the following maturities

  • Short term - Less than 12 months
  • Medium term - 2 to 3 years
  • Long term

If the installment loan is a long term loan then it may span over many years. Typical example of an installment loan is a mortgage which at most can span over 30 years.

Auto loan is a medium term debt. It spans for a period of a few years, typically 3 to 5 years. All other loans that have a repayment term of 12 months or less are short term installment loans and therefore have to be paid within 12 months.

When a borrower gets approved for the installment loan, the lump sum amount is transferred into the account of the borrower. The borrower is then required to pay back the full amount plus interest over the maturity or term limit of the loan as specified in the terms and conditions.

What is a Payday loan

A payday loan is a short term loan that can be predatory in nature, therefore it carries a very high rate of interest which is meant to prey upon the vulnerabilities of those who cannot afford to pay back on time.

Let us now look at the differences between these two loan times.

Loan term

One major difference between installment and payday loans is that of their term limits or maturities.

Installment loan

  • Installment loan

The term installment loan is a very broad term and can include any loan from a short term loan spanning over a few months to a 30 year mortgage. Thus, installment loans are very flexible when it comes to term limits.

  • Payday loan

Payday loans typically cover only a month, hence their name PAYDAY! Lenders aim to deduct the amount owed from the borrowers very next paycheck directly. Borrowers are required by lenders to write a post dated check to the lender. The due date on pay day loans is usually between 2 to 4 weeks.

Cost

Cost is another area where installment and payday loans differ from each other.

  • Installment loan

Installment loans can carry fixed or variable interest rates. Since the installment loans are typically available from banks, their interest rate is market competitive and not predatory. Borrowers with low credit scores may get slightly costly loans and if the credit score is bad then the bank may simply refuse to lend the loan. The cost therefore of installment loans is low to moderate, as banks only consider creditworthy borrowers.

  • Payday loan

Payday loans are meant to be used in emergencies, they are financial firefighting loans that are only meant to be used in the most dire of circumstances. For this reason most borrowers who turn up for payday loans have low or very bad scores and have already been rejected by banks. Payday lenders therefore take advantage of this vulnerability to charge predatory terms and rates from the borrowers. The APR on a typical Payday loan may range upto 400% which is a stupendously high amount. Credit cards in comparison to Payday loans only charge APR up to 30%.

Borrowing limit

Borrowing limit is another area where installment and payday loans differ significantly.

  • Installment loan

Installment loans are your conventional loans. They can be either secured or unsecured and their borrowing limit can start from several hundred dollars to several thousand dollars.

  • Payday loan

Payday loans on the other hand are unsecured loans that are meant for financial firefighting. As their name implies, they are PAYDAY loans, thus their borrowing limits are usually limited to a few hundred dollars at maximum. At most a payday loan can be for $500 or less. Since payday loans are predatory in nature, the lenders do not consider the credit worthiness or the ability to repay the loan.

Lender

Another major difference between these two loan types is of availability and lender.

  • Installment loan

Installment loans are available through conventional banks and credit unions. Anyone can therefore easily access these loans as long as they have got a good enough credit score.

  • Payday loan

Payday loans are typically available through online lending sites. If however the state laws require it then payday lenders may also operate through storefront.

Hopefully this article has been able to clarify the differences between installment and pay day loans. Both loans target different ends of the spectrum. While installment loans can be used to fund personal expenditure, payday loans are a more dangerous territory and should only be seen as a financial fire fighting option in case there is no other option.

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