October 2, 2024
Sometimes, life throws curveballs: Your air conditioning unit dies in the heat of summer, your pet requires costly surgery, or your vehicle needs a new set of tires. When your emergency fund doesn’t quite cover it, you might need financial help — and fast.
A loan can be a great option to cover the cost of a large purchase and spread out payments over a longer period. However, people with bad credit or no credit history may believe that their only option is to turn to payday loans. These short-term loans certainly offer cash fast, but they also come with often-unexpected conditions and penalties that can make it a financial move that costs far more than expected. Read on to discover the difference between payday loans and installment loans, and how anyone — even those with bad credit — can qualify for an affordable loan.
If you need money to cover a large purchase, you may be considering a payday loan or an installment loan. Both loan types are an agreement between you (the borrower) and a lender. The lender gives you a sum of money, and in return, you agree to repay it with interest. However, payday loans typically must be repaid in one lump sum, while installment loans are paid back over several months or years. These loan types also differ in cost to borrowers and how lenders determine creditworthiness.
A payday loan is a very short-term loan. Lenders offer a portion of your upcoming paycheck as a loan, which must be paid off on your next payday. These loans can have extremely high interest rates — 400% on average — that significantly hike up the total price of the loan. This interest rate alone can make installment loans a more affordable option. A payday loan has tight timelines for repayment and, considering that payday loan borrowers are often already low on cash, this can make it challenging for individuals to regain control of their finances. In fact, payday lending’s high costs are sometimes considered predatory and have led to the loan type being prohibited or significantly limited in 21 states and the District of Columbia.
When a borrower gets a payday loan, they receive a portion of their paycheck in advance. In return, the borrower must repay the loan in one lump sum the next time they receive a paycheck, Social Security benefit, or any other recurring income. This means most payday loans must be paid off within 30 days. If borrowers are unable to repay the loan in full, they may be able to renew the loan until the next payday, which means interest continues to accrue and additional fees are applied to the loan cost. In some cases, if renewal is not possible, borrowers might need to take out a second payday loan to repay the first. This can lead to a vicious cycle in which borrowers are unable to fully pay off their existing debt without borrowing more money.
Payday loans are unsecured, meaning the lender does not hold collateral to ensure that the borrower will repay the loan. However, lenders often require a signed, postdated check or direct access to the borrower’s bank account to withdraw the full loan amount plus interest. That takes the power of payment out of the borrower’s hands, and an individual may struggle to pay other important bills, such as housing or groceries. If the account balance does not cover the total amount, borrowers are subject to their bank’s overdraft or returned check fees.
Payday lenders ask for minimal information, such as proof of income and bank account numbers, to approve a loan. They do not review credit reports or scores, making this seem like an attractive option for borrowers with bad credit. However, this means that lenders can give payday loans to borrowers who can’t comfortably repay the loan amount while also covering other necessary bills and expenses.
Any type of loan that is provided to the borrower in a lump sum and repaid in several payments is considered an installment loan. This can include personal, auto, student, and home equity loans, mortgages, and more. Payments are usually made monthly, and terms — the length of repayment — can vary from a few months to several years. Interest rates for installment loans differ by loan type, current market averages, and the borrower’s credit score, but they are usually significantly lower than payday loan rates.
Installment loans can vary widely depending on the loan type. For example, a personal or home equity loan is paid to the borrower as a lump sum and can be spent just like cash, while a mortgage or auto loan is paid to the seller and/or their lender. The time it takes to get funds can differ, too. While mortgage approval and funding can take several weeks to process, personal loans are relatively fast. For example, with a Lendly loan, borrowers can receive their funds in as soon as 24 hours.
There are several types of installment loans, some of which require collateral, making them secured loans. For example, an auto loan is secured because the lender holds the title to the vehicle until it is paid in full. If a borrower skips several auto loan payments, their vehicle may be repossessed by the lender to cover the debt. Personal loans, meanwhile, are not secured. Lenders do not require collateral to ensure repayment, but a missed payment can negatively impact your credit score for seven years.
When you apply for an installment loan, you will be asked to provide personal and financial information, such as your Social Security number and proof of income. Lenders review your credit history, income, and expenses to ensure that you can adequately repay the loan without experiencing financial hardship. However, having bad credit does not mean a borrower will be automatically declined. For example, Lendly strives to make installment loans attainable for people with poor credit or no credit history and offer loans with competitive, fair rates and no hidden fees.
In an emergency, you might feel like a payday loan is your only option for fast funds. However, other types of credit can offer greater flexibility and affordability. In addition to a personal loan, consider the following alternatives to a payday loan:
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