Would a payday loan by any other name cost as much? That’s the question installment loans raise. Like payday loans, installment loans are marketed to cash-strapped folks who need a small loan to bridge an income gap or cover an emergency expense. Also like payday loans, their effective interest rates are often higher than their advertised interest rates.
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Irregular income can sometimes cause a serious budget problem. Folks who don’t have regular hours can find it tough to know how much they’re going to make, which in turn makes it tough to keep up with bills. Anyone in that situation who doesn’t have an emergency fund may be tempted to turn to an installment loan.
Installment Loans: The Basics
An installment loan is a form of consumer credit in which the borrower gets a small loan and agrees to make a series of monthly payments to repay the loan. These payments are the “installments” that clear the loan.
Here’s how installment loans are different from payday loans: With a payday loan, the borrower writes a future-dated check for an amount equal to the sum being borrowed, plus a fee. At the end of the loan term, the borrower can either tell the payday lender to cash that check or get a new loan to extend the payment term.
In other words, payday loans are designed to be cleared by a single lump sum payment from the borrower’s checking or savings account, whereas installment loans are designed to be paid off in smaller chunks over time and don’t necessarily require the borrower to have a bank account.
Both payday loans and installment loans are generally marketed to low-income Americans but installment loans in particular are often marketed to the un-banked. Unlike payday lenders, installment lenders report loan activity to the three credit reporting agencies. That means that whether or not you keep up with payments on your installment loan can impact your credit score. This can be a good thing if you are able to keep up with the payments. It can also cause a drop in your credit score if you are not.
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Installment Loan Risks and Pitfalls
In many places, installment loans have taken the place of payday loans as regulators crack down on abuses in the payday loan industry. Some states don’t permit payday lenders to operate within their borders, or have interest rate caps that have deterred payday lenders. New regulations and rate caps generally don’t apply to installment lenders. That’s why in many places installment loans are the new payday loans. The catch? Installment loans aren’t necessarily better than payday loans.
Installment loans come with a nominal interest rate, the APR (Annual Percentage Rate) that the lender advertises. But they also come with added fees and multiple forms of credit insurance. Many borrowers don’t realize these insurance policies (things like credit life insurance and credit disability insurance) are optional. So, the borrower agrees to finance the insurance policy charges along with the loan. That adds to the amount the person is borrowing, making the effective interest rate on, say, a $300 loan much higher than advertised. Think triple digits.
Then what happens? Installment lenders allow borrowers to renew their loans. When you renew an installment loan, the lender gives you back a portion of what you’ve already paid, taking cuts for insurance payments and fees. You walk away with a little cash in your pocket, but your loan starts all over again, with new fees. Loan renewal is how installment lenders make money from folks who need small short-term loans. It’s what can lead to a debt spiral.
Alternatives to Installment Loans
Too spooked to consider an installment loan now? There are alternatives – and we don’t mean payday loans. Let’s say you originally wanted an installment loan because you have bad credit. What other options are there for personal loans for folks with bad credit? It might be a good idea to consider peer-to-peer lending sites. Some of these sites are willing to lend to folks with bad credit. The best ones offer transparent interest rates and fees with no added insurance policies.
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If you have average or good credit, your rates are likely to be quite low if you go through a peer-to-peer lending company. You could also apply for a personal loan from a bank or credit union. Whatever your credit score, you may also want to approach friends and family for help with a loan, or look into a lending circle.
An installment loan is a consumer credit product that’s designed to make lenders money. If you must get an installment personal loan, it’s important to make every effort to pay it off on time. Also remember that you have a right to turn down any voluntary insurance plans your lender pitches.
Oh, and it’s a good idea to think carefully before renewing the loan. It can be tough to turn down an offer of cash-in-hand from an installment lender, but loan renewal can lead to that debt spiral. Once you go down the path of loan renewal it can be hard to get off of it.
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