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What to know about payday loans and installment loans

Installment Loans and Payday Loans: 3 Differences To Know

Both installment loans and payday loans fall under the category of small-dollar, high-cost loans, characterized by elevated interest rates and relatively modest loan sums.

Individuals utilizing these financial products typically possess a lower credit score or lack a credit history, compelling them to explore alternative sources of funding. When a borrower lacks access to credit cards or loans from traditional banks or credit unions, they gravitate towards loan options that circumvent the need for a credit check.

Consequently, in such scenarios, borrowers invariably face higher interest rates compared to those associated with conventional loans.

What Is a Payday Loan?

A payday loan is an advance on your next payroll check. The amount you could receive typically ranges from $100 to $1,500. This is an unsecured, short-term loan that is usually required to be repaid on your next payday.

This is usually done with a post-dated check the borrower writes when securing the loan or with an automatic electronic funds withdrawal. 

The lender will charge fees and interest on the loan in addition to the borrowed principal amount. The amount you could receive is based on your income and ability to repay the loan. If the borrower cannot repay their loan in full on their next payday, the balance can be rolled over for another week, although they will incur additional fees and interest.

Payday Loans Risks To Know

Before diving into a payday loan, it's essential to recognize the potential pitfalls that come with this seemingly convenient option. One of the most glaring concerns is the sky-high interest rates and fees that often accompany payday loans.

The Annual Percentage Rate (APR) for these loans can reach astonishingly high numbers, making repayment challenging and potentially trapping borrowers in a cycle of debt.

Another risk stems from the short repayment window typically associated with payday loans. With repayment often due on your next payday – which can be just a few weeks away – borrowers can find themselves in a tight financial spot, struggling to cover the loan along with their regular expenses.

This can lead to the temptation of extending the loan, but doing so incurs additional fees and can create a precarious debt cycle that's tough to escape. It's vital to carefully assess whether the immediate relief offered by a payday loan is worth the potential long-term financial strain.

What Is an Installment Loan?

An image of an installment loan agreement.

Ok, now that you know what these loans are, how do they differ?

1. Loan Repayment

A fundamental contrast between installment loans and payday loans lies in their repayment structures. Installment loans, true to their name, involve borrowing a lump sum that you repay over a predefined period through a series of scheduled installments.

This extended timeline not only provides more breathing room for repayment but also enables you to manage your finances more effectively. On the other hand, payday loans follow a different approach. These loans are designed to be short-term solutions, with the repayment typically due on your next payday or within a few weeks.

2. Payday loan and Installment Loan Amounts

When it comes to the amount of funds you can access, installment loans and payday loans display notable discrepancies. Installment loans generally offer more substantial borrowing limits compared to payday loans. This makes them a preferred choice for individuals facing significant expenses, such as medical emergencies or major home repairs.

 Conversely, payday loans are tailored for immediate, smaller-scale financial needs and typically provide a loan amount that corresponds to a percentage of your regular income.

Compared to a payday loan, the amount you can receive with an installment loan ranges from about $150 to several thousand dollars. Because an installment loan is a secured loan, being approved will be determined by your credit history and your income.

3. Credit Check and Approval Process

The application and approval processes for installment loans and payday loans also diverge. Installment loans typically involve a more comprehensive credit assessment, where lenders evaluate various financial factors to determine your eligibility and assign an appropriate interest rate.

This thorough evaluation is often a reflection of the longer repayment period associated with installment loans. In contrast, payday loans may have a simpler approval process that places less emphasis on your credit history. This streamlined approach can make payday loans more accessible for individuals who have lower credit scores or limited credit history.

Your overall net worth will also be considered, as well as how long you have lived at your home, your monthly expenses, and various other factors. 

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