Editor: David Reiss
Brooklyn Law School

April 4, 2017

Payday v. Installment Loans

By David Reiss

photo by Azaj Kilafa quoted me in What’s the Difference Between a Payday Loan and an Installment Loan? It opens,

If you’re looking to borrow, you may already know about payday loans—they’re fast, dangerous, and designed to take advantage of those in need. (Think of them as the jackal of the lending animal kingdom.) Is there a better option? Something just as fast, but… you know, not evil?

You bet there is.

When it comes to lending, consider the personal installment loan the noble lion, king of the lending jungle.

Payday loans are short-term, unsecured loans that target the financially vulnerable—the low income, the elderly, and those without limited financial education. Payday lenders won’t perform a credit check and, depending on the restrictions in your state, they may not even check your income first.

Fast money without a credit check? What could be wrong?

Well, a lot. Payday loans charge unfair fees and massive interest rates, meaning they have extraordinarily high annual percentage rates (APR)—the measurement that allows you to see the full cost of loans.

Certified financial educator Maggie Germano (@MaggieGermano) says, “Payday loans usually turn out very negatively for the borrower. Interest rates and fees are sky-high and many people are unable to pay them back in time. Every time you miss your payment due date, the amount owed increases significantly. This makes it impossible for people living paycheck to paycheck to pay them off. This can destroy a borrower’s credit and wipe out their bank account.”

It may be tempting to try out the fast, risky option with the short payment terms, but don’t forget: it’s a trap.

When it comes to payment terms, installment loans are the exact opposite of payday loans. Instead of having to make a massive payment in a short amount of time, installment loans offer you the chance to make regular, smaller payments over a much longer period of time.

Most installment loans will offer you a MUCH lower APR on your loan than a dangerous payday loan and also—unlike many payday loans—they won’t charge a sneaky prepayment penalty.

What’s a prepayment penalty? Law professor David Reiss (@REFinBlog) sums it up well: “Prepayment penalties come into play if the borrower repays all or part of a loan before the payment schedule that the borrower and lender had agreed upon when the loan was first made. In theory, they compensate the lender for the costs of making the loan in the first place and any decrease in interest payments that the lender would get as a result of early repayment. In practice, prepayment penalties can be a new profit center for lenders if the fees are set higher than the amounts actually lost by prepayment.”

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