Payday Loan vs. Installment Loan: Key Differences

If you need cash fast, your options often come down to installment loan vs. payday loan. While both offer money when you need it most, there are major differences that you should weigh carefully. Payday loans typically carry higher interest rates and fees than installment loans, potentially trapping consumers in a cycle of debt. You'll also need to repay the payday loan in full, usually after two weeks. Read on to understand the key difference between payday loan and installment loan to choose the best option to protect your financial well-being. 

What is a Payday Loan?

A payday loan is a short-term borrowing option. Payday loans target consumers in a cash crunch who need to make ends meet. Most people turn to payday loans for emergency expenses such as unexpected car repairs, medical fees, fines, or to cover a credit card payment until a paycheck arrives. 

The term payday loan comes from the idea that you should take the loan to make ends meet until your next payday. Payday loans vary widely by lender. Some standard features include: 

• No background checks
• Short duration, usually two weeks or less 
• Full repayment when the loan is due 
• High-interest rates
• Annual percentage rates (APRs) of 300% to 500% are common
• High fees
• Rollover options that can lead to accumulating more debt 
• Small loan amounts (usually $500 or less)

While some payday loans include a credit check, many don't perform a credit check. You can typically walk into a payday loan lender and walk out with cash in under an hour. 

What is an Installment Loan?

An installment loan is any loan with a set number of payments and a set repayment schedule. Personal loans, auto loans, and mortgages are all examples of installment loans. Key features of installment loans include:

• Set amount with repayment terms from a few months up to many years
• Long-term borrowing arrangement
• Usually have fixed interest rates (unless it's a variable-rate loan)
• May have interest rates from 4% to 30% or more
• Loan amounts range from $500 to $50,000 or more

An installment loan typically has interest rates and terms that are more favorable for borrowers than payday loans. By allowing you to pay off the loan in monthly installments over time, you can effectively build an installment loan into your long or short-term financial planning. 

Key Differences Between Payday Loans vs. Installment Loans

The fundamental distinctions between installment loan vs. payday loans include loan structure, repayment schedule, interest rates, credit score impact, and eligibility criteria.

Each loan type has pros and cons, detailed below, to help you make an informed decision.

Loan Structure and Repayment

When comparing installment loan vs. payday loan, repayment plans are the first key difference. Payday loans are typically repaid in one lump sum on the borrower's next payday, while installment loans are repaid over a series of scheduled payments. 

For most borrowers needing fast cash, spreading the repayment even over a few months can make a huge difference in their ability to repay the loan on time. When you have more time to repay the loan, building loan repayment into your total financial planning is more manageable. 

Loan Amounts and Eligibility

While loan amounts can vary with an installment loan vs. payday loan, payday loans usually offer smaller amounts. Installment loans offer higher sums, offering borrowers the option to secure some additional cash and then plan to pay it back over time. This reduces the chance of needing an additional loan.

Payday loans often don't require a credit check, making them an attractive option for borrowers with low or no credit scores. However, some payday lenders may perform a credit check or ask for income verification. 

For installment loans, lenders typically ask for income verification and perform a credit check to determine loan eligibility and terms.

Interest Rates and Fees

Another major difference between installment loan vs. payday loan is interest rates. Interest rates of payday loans can be significantly higher due to their short-term nature. It's common to find payday loans with an APR of 400% or more. Payday loans may also have high fees that further burden the borrower's repayment ability.

Installment loans have interest rates from 6% to 30% or more. These are generally significantly lower than payday loans. While installment lenders may also charge additional fees, these are typically lower, relative to loan amounts, than those charged by payday lenders. 

Usage Scenarios

Common scenarios where borrowers might opt for payday loans include emergencies or immediate cash needs where they don't have another way to get the cash fast. 

On the other hand, installment loans are often used for more significant expenses, such as purchasing durable goods or financing a major life event. However, you may also use installment loans for emergencies like car repairs, medical expenses, home repair or fees. 

Impact on Credit Score

When you take an installment loan, the lender will report loan activity to credit bureaus. Timely repayment of installment loans can positively impact your credit score, potentially helping you build a good credit history.

Payday loans do not usually have credit-building potential due to short repayment periods. Likewise, not all payday lenders report to the credit bureaus unless the borrower fails to repay the loan. 

Long-Term Financial Implications

Any comparison of installment loan vs. payday loan would be incomplete without a serious warning about the long-term potential harm of payday loans to borrower's financial health.

Payday loans carry a significant risk of trapping borrowers in a cycle of debt. The high interest and fees, combined with the predatory practices of some payday lenders, can mean that borrowers who cannot repay the loan are forced to roll it over for high fees, leading to repeated borrowing and high-interest charges.

On the other hand, with an installment loan, you can spread the loan repayment out over a longer period. This makes it easier for borrowers to plan for loan repayment. In the long term, an installment loan with responsible repayment management can contribute to stable financial growth and a higher credit score.

Choosing the Right Option

Borrowers can choose to take on payday loans vs installment loans based on their financial needs and circumstances. Assess factors like repayment ability, loan purpose, and long-term financial goals when deciding which type of loan to pursue.

If you can apply for an installment loan, even a higher interest rate on an installment loan will typically be less than a payday loan. That means you'll pay less in interest and fees. You'll also be able to choose a manageable repayment term for your financial situation. 

Alternatives to Payday and Installment Loans

In today's fast-paced and ever-changing economy, many individuals find themselves in need of quick financial assistance to cover unexpected expenses or bridge the gap between paychecks. However, with the rise in popularity of payday and installment loans, it's essential to consider the alternatives that can offer a more sustainable solution.

• Borrow from friends or family: One alternative to payday and installment loans is borrowing from friends or family. This option allows you to avoid the high interest rates and fees associated with traditional lending methods. By reaching out to loved ones, you can establish a repayment plan that is more flexible and tailored to your financial situation. However, it's crucial to approach these arrangements with responsibility and respect, ensuring that you clearly communicate repayment terms and follow through on your commitments.
• Find Payday Alternative Loan (PAL): This is a financial product is offered by credit unions and is designed to provide consumers with a more affordable borrowing option during times of financial need. They often offer lower interest rates and more flexible repayment terms, making them an attractive choice for those seeking financial assistance. Additionally, credit unions typically work closely with their members to ensure they make informed decisions and provide personalized advice throughout the borrowing process.
• Utilize credit cards: Using a credit card can be a more affordable and manageable option, allowing you to borrow and reuse funds while repaying your balance. Credit cards generally have lower interest rates and offer flexibility in repayment. However, responsible financial management is important to avoid accumulating high-interest charges and falling into further debt.

In conclusion, payday and installment loans may seem like quick and convenient options when facing financial emergencies. However, considering the alternatives mentioned above can provide more sustainable solutions that ensure you maintain your financial well-being in the long run. Take the time to research and evaluate these alternatives to make an informed decision and avoid falling into a cycle of debt.

Building Your Financial Future

Whether you choose payday loans vs installment loans, consider other opportunities to build an emergency fund. Find some of the best personal loans, personal loans for fair credit scores, and personal loans for excellent credit scores. If you want to start saving more, find some of the best high-interest savings accounts.

Frequently Asked Questions