What Is the Difference Between a Loan and a Payday Loan?
A payday loan — which is often referred to as a payday advance, cash advance loan or a salary loan — is a short-term, small amount loan that a borrower repays at their next payday.
The amount you pay back is the amount you borrow plus a fee. For example, if you borrow $200 from a payday loan company that charges $20 for every $100 borrowed, you must pay back $240.
Most payday loan lenders require you to set up an automatic payment from your checking account. They electronically deposit the funds for your loan into the checking account and then automatically withdraw the funds for the repayment at the agreed-upon time.
Payday loans differ from more traditional installment loans in their terms. With an installment loan, you don’t pay the amount plus fees back right away with your next paycheck. Instead, you pay the amount you borrow plus interest over a period of time in a series of installments. Installments may be paid weekly, biweekly, or monthly, depending on the terms you agreed to with your lender.
What Is Better: a Payday Loan or an Installment Loan?
Installment loans are typically a better choice than payday loans. Here are just a few reasons you might want to go with an installment loan when looking for short-term cash to meet an unexpected need:
- Potentially better interest rates. Payday loans have extremely high interest rates. Many people don’t realize this because of the way the loans are structured. They have a “fee,” and payday loan lenders may not use the term interest. But when you’re being charged $10 to $30 per hundred you borrow and expected to pay that back within a few weeks, the resulting interest rate can reach more than 600%.
- Access to higher amounts. Payday loan amounts are based on how much you can pay back on your next payday. That limits how much you can borrow, as most lenders won’t even let you borrow the total amount of your paycheck. Installment loans are based on how much you can afford to pay back over a longer period of time, which may make it possible for you to borrow more money.
- Helps build your credit. If you work with an installment loan lender that reports to the credit bureaus, your loan can help you build credit for the future. Making timely payments on your loan increases your positive payment history, which in turn can increase your score. Many payday loan lenders don’t report your payments to the credit bureaus, so such loans don’t help you build credit.
Are Payday Loans Easier or Harder to Pay Back Than Installment Loans?
Payday loans tend to be harder to pay back because they require a substantial amount out of your next paycheck. If you are relying on a payday loan to make ends meet, your next paycheck may also be stretched. Having to use it to pay back the loan can put you back in a financial bind a few weeks from now.
An installment loan requires smaller payments over a longer period of time. That structure helps you pay back the debt without creating that financial burden in immediate weeks.
Why Should You Avoid Payday Loans?
Some people get caught up in what’s known as the payday loan trap. This occurs when you take out a payday loan for an unplanned expense and intend to pay it back fully on your next payday. But something else happens in the meantime and you need your entire next paycheck to make ends meet.
Many payday loan companies let you roll the existing loan into a new one, putting off paying it back until your next payday. Of course, they don’t offer this courtesy for free. You pay a rollover fee, increasing the amount you have to pay back (and the interest on your loan). You may also make it that much harder to pay back the loan without major financial issues in your personal budget.
Frequently Asked Questions
What are two types of payday loans?
Payday loan companies offer a few options, including:
- Paycheck advance loans.
- Post-dated check loans. You write a check for a certain day in the future to cover the loan plus any fees. The lender gives you the money now and cashes the check on the agreed-upon date.
