If you need cash to cover an emergency expense, like a car repair or medical bill, a payday loan or an installment loan are two options you may consider. However, these two loans are different in key ways that are crucial to understand before making a choice between them. Namely, a payday loan tends to have a short turnaround before you need to pay it off, and typically offers extremely high interest rates.
We’ll explain more about the features of each loan type, and why people choose payday loans vs installment loans.
What Is a Payday Loan?
There is no set definition of a payday loan. Generally speaking, they are short-term loans that are due to be paid back on your next payday. Payday loans don’t charge interest per se, but they do charge high fees.
Payday loans are typically for relatively small amounts. In fact, many states limit the amount of a payday loan to $500. Borrowers usually repay the loan in a lump sum on their next payday. The specific due date is often between two and four weeks from when the loan was made.
To repay the loan, borrowers must make out a post-dated check to the lender for the full balance of the loan plus any fees. As an alternative, borrowers can give permission for the lender to electronically debit the funds from their bank account on a certain date. If the borrower doesn’t repay the loan by the due date, the lender can cash the check or debit the funds — either way, the lender gets paid.
In some states, borrowers may be able to roll over the amount of the loan, paying only the fees when it comes due, while the lender pushes out the due date.
Risks of a Payday Loan
The risks of payday loans include sky-high fees and the potential for falling into a cycle of debt. Many states set a limit on payday loan fees, but they can still run from $10 to $30 for every $100 borrowed. Consider that a $15 fee for $100 is the equivalent of nearly 400% APR. By comparison, the average personal loan interest rate is 9.41%, according to the Federal Reserve of St. Louis.
Pros and Cons of Payday Loans
Before signing on for a payday loan, carefully consider the advantages and disadvantages.
| Pros of Payday Loans | Cons of Payday Loans |
|---|---|
| Provide quick access to cash, often with same-day turnarounds. | Very expensive, with fees equivalent to a 400% APR. |
| No credit check required. To qualify, you typically need to be 18 years old, have a government I.D., bank account, and regular source of income. | Lenders don’t consider your ability to repay the loan, and the loan doesn’t help you build credit. As a result, these lenders are considered “predatory.” |
| Unsecured: Borrowers are not required to put up property as collateral. | Borrowers can get trapped in a cycle of debt. If they are unable to pay back the loan, borrowers will pay expensive fees each time they roll over or renew their loan. |
What Is an Installment Loan?
When a borrower receives an installment loan, their lender will give them a lump sum upfront, which the borrower has to repay in fixed payments with interest over a set period of time. Personal loans are a good example of an installment loan.
They can range in size from a few hundred dollars to $100,000, and the money can be used for any reason, from covering unexpected expenses or consolidating debt to remodeling a home. Repayment terms may stretch from a few months to a few years.
How Installment Loans Work
During the loan application process, lenders will consider factors such as a borrower’s credit score and reports, their income, and the amount and length of the loan.
Typically, borrowers with good credit scores will receive the best terms and interest rate options. These loans may have variable interest rates or fixed, meaning they don’t change over the life of the loan.
Installment loans may be secured or unsecured. Unsecured loans, such as unsecured personal loans, do not use collateral to back the loans. Secured loans do require collateral and may offer borrowers a lower interest rate since they present less risk to the lender.
Recommended: How to Get Approved for a Personal Loan
Pros and Cons of Installment Loans
Personal installment loans tend to offer borrowers the option of borrowing at lower rates than are available through revolving credit or payday loans. However, it’s still important to consider disadvantages in addition to benefits.
| Pros of Installment Loans | Cons of Installment Loans |
|---|---|
| Borrowers can finance a big purchase over a period of up to several years. . | Interest rates may be higher than other alternatives, such as a home equity line of credit. |
| Payments typically remain fixed over the life of the loan, unless the borrower chooses a variable interest rate. | May be subject to fees, such as closing costs. |
| Secured loans don’t require collateral, while unsecured loans may offer lower interest rates. | Missed payments can damage credit scores. Defaulted loans may be sent to collections. |
Payday Loans vs Installment Loans: Key Differences
By now you’ve likely got a good sense that installment loans and payday loans differ in some important ways. Here’s a side-by-side comparison.
| Payday Loans | Installment Loans | |
|---|---|---|
| Repayment terms | Payment is due on the borrower’s next payday, usually two to four weeks from the date the loan was taken out. | Loan is repaid in regular installments, often monthly, typically over 2 to 5 years. |
| Loan amounts | Often limited to $500. | Can range between a few hundred dollars and $100,000. |
| Interest rates | Payday loans don’t charge interest, but they do charge costly fees that can be the equivalent of up to 400% APR. | Interest rates vary, depending on a borrower’s credit history, among other factors. The average personal loan interest rate is 9.41%. |
| Use cases | Payday loans are typically targeted to borrowers with poor credit and few other lending options. Loan money can be used for any reason. | Some installment loans, such as auto loans or mortgages, are limited in how they can be used. Personal loans can be used for any purpose. |
| Risk | Payday loans are predatory loans that can trap borrowers in a cycle of debt. Lenders don’t consider a borrower’s ability to repay the loan, and the loan won’t help build credit. | Failure to repay an installment loan on time can damage credit. Defaulting on secured loans may result in loss of property. |
| Credit requirement | None. | The application process for installment loans requires a credit check. |
Why You Should Avoid Payday Loans
Payday loans are usually predatory in nature and should be avoided. Fees make them an expensive form of credit. If you don’t have the money to repay it on the due date, lenders may try to cash the post-dated check, which will bounce, triggering fees. Or if you provided your bank account information, the lender may try to withdraw the funds, triggering overdraft fees with each attempt.
Payday lenders might also sell your loans to a debt collector, which can lead you to being harassed by collections calls.
Explore SoFi’s Low-Rate Personal Loan Options
Payday loans and installment loans both provide quick cash to cover emergency expenses. However, because of their astronomical fees — equivalent to a 400% APR — payday loans fall under the heading of “predatory lending.” On the other hand, installment loans vary in their terms but generally are a much better deal, provided that you meet eligibility requirements.
Considering options for borrowing? Check out personal loans from SoFi with low fixed rates on loans between $5,000 and $100,000. What’s more, personal loans from SoFi charge no fees and offer funding as quickly as the same day the loan is approved.
FAQ
Are payday loans installment loans?
No, payday loans usually require you to pay off the loan amount in full on your next payday, usually two to four weeks from when the loan was made.
What is an installment loan?
When you take out an installment loan, you immediately receive the money you’re borrowing. You then pay it back to your lender in a series of regular fixed payments known as installments.
Are personal loans installment loans?
Personal loans are one type of installment loan. Money from the loan can be used for any purpose, such as debt consolidation or a home remodel.
Photo credit: iStock/Prostock-Studio
SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.
Checking Your Rates: To check the rates and terms you may qualify for, SoFi conducts a soft credit pull that will not affect your credit score. However, if you choose a product and continue your application, we will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull and may affect your credit.
SOPL0622008