If you happen to find yourself in a tight spot, borrowing money can help set you back on the right path. However, doing so without a full understanding of the facts can hinder your finances in the future.
The two most common types of small-dollar borrowing are traditional installment loans and payday loans. Knowing the ins and outs
of each type of loan and how they work can help you make the best decision for your financial situation.
Traditional installment loans are one of the oldest forms of finance transactions and provide credit to individuals and families who need access to credit to meet an immediate need, such as vehicle repairs, household appliances or medical expenses. Averaging
around $1,500, traditional installment loans are “plain vanilla” loans with transparent, easy-to-understand repayment terms, due
dates and payment amounts – which usually average $120 per month over a term of about 15 months. With regular, manageable payments of principal and interest, the borrower has a clear roadmap out of debt. Best of all, traditional installment lenders report payment activity to credit bureaus, improving a borrower’s credit score when payments are made on time.
Payday loans are repaid in a single balloon payment at the end of the loan period. This payment is usually due in less than 30 days and frequently the term is as short as 14 days. Payday lenders do not assess ability to repay, relying instead on a postdated check or similar access to a borrower’s bank account as assurance the loan will be repaid. If a borrower cannot afford to repay a payday loan in full when it comes due, they are left with no option but to refinance the entire balance of the initial loan. Although payday loans may appear to provide a quick and easy solution, this single, lump-sum payment can lead to significant problems for the borrower. Payday lenders have also been sanctioned in many states, and at the federal level, for abusive practices.
When you take out a loan, it’s important to understand the complete cost of repaying the amount you’ve borrowed. It’s a good idea to compare offers from multiple creditors and understanding these terms will help you calculate the real cost of borrowing to get the best deal. Here is a list of common loan terms from the American Financial Services Association Education Foundation:
– Amount Financed: The total dollar amount of the credit that is provided to you.
– Annual Percentage Rate or “APR”: A measure of the cost of credit expressed as a yearly rate.
– Credit Insurance: Optional insurance that is designed to repay the debt if the borrower dies or becomes disabled.
– Finance Charge: The dollar amount you pay to use credit.
– Fixed Rate Financing: The interest rate and the payment remains the same over the life of the loan. Equal monthly payments of principal and interest are made until the debt is paid in full.
– Length of Payment: The total number of months you have to pay the credit obligation.
– Late Payment Fee: A fee that is charged when payment is made after its due date.
– Monthly Payment Amount: The dollar amount due each month to repay the credit agreement.
Is an Installment Loan Right for You?
When deciding whether to obtain a loan, consider the benefits and responsibilities. According to the American Financial Services Association Education Foundation, an installment loan:
– Obligates future income. You’ll be required to set aside a certain amount of future income for loan payments.
– Requires discipline. Borrowing wisely means not borrowing more than you can handle.
– Allows you to obtain products and services now and pay for them later. A loan can provide an opportunity to purchase bigger-ticket items and use them right away.