Payday Loans vs Installment Loans: What’s the Difference and Which Is Better?

Payday loans and installment loans are both options when you need fast access to cash, but they differ when it comes to cost, repayment structure, and long-term impact on your finances. 

With payday loans, you generally need to repay the full amount by your next payday, and the interest rates you’ll pay to borrow money can be incredibly high. On the other hand, installment loans have longer repayment terms and usually charge more reasonable interest rates. 

It’s important to understand the differences and tradeoffs before you take out a loan to avoid costly debt cycles and make sure you’re picking the best option for your needs and budget.

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Payday Loans vs Installment Loans at a Glance

The biggest structural difference between payday loans and installment loans involves repayment. With payday loans, you’re expected to repay the entire amount you borrowed by your next payday. The exact timeframe varies depending on the payday lender, but that usually means a repayment term of two to four weeks or less. With installment loans, you'll repay the amount you borrowed in monthly installments over the course of several months or even years, with the exact timeframe depending on the size of the loan and other factors.

Another big difference is the cost to borrow money. Payday loans are considered predatory — and are even illegal in certain states — because they charge interest rates as high as 300% to 400%. With an installment loan, interest rates are typically much lower, topping out around 36%. 

Why are the costs so different? Because payday loans are much easier to get. They usually don’t require a credit check, making them accessible to borrowers who have poor credit that disqualifies them from personal installment loans that often have minimum credit score requirements. If you have a high credit score and take out an installment loan, you may be eligible for a competitive interest rate, such as 6% APR or less.

How Payday Loans Work and Why Are They So Expensive?

How the Repayment Model Works

When you take out a payday loan, you're usually limited to borrowing a small amount of $1,000 or less. Once you apply and sign all required forms, the lender will transfer the funds to your checking account. 

Then, you'll generally be required to repay the loan by your next payday, though the exact timeframe will vary depending on the lender you’re working with. Payday lenders usually require you to link your bank account so it can detect when your paycheck hits and automatically withdraw your repayment. Or you might be able to write the lender a post-dated check for repayment that it can cash on the specified date.

Payday Loan APR and Fees: What You'll Actually Pay

When you borrow money with a payday loan, you could easily end up paying double or more the amount you borrowed.

Here's an example. Say you borrow $400 from a payday lender to help cover rent before your next paycheck hits. 

• The payday lender charges an APR of 391%, and you’ll need to repay the loan in two weeks. 

• That works out to an interest rate of 15.04% for the two-week period — 391% APR divided by 26 two-week periods in a year — which translates to $60.15 in interest.

• Your total repayment due in two weeks will be $460.15.

That may not seem like much, but the fees represent more than 15% of the money you’re borrowing. And it only gets more painful when you borrow a larger sum of money. If the lender charges other fees, like an instant transfer fee, on top of the interest rate.

If you can't repay the $460.15 within two weeks, you’ll be hit with rollover fees for carrying the balance past the original due date. Many payday lenders charge a rollover fee equal to the original loan fee to extend the loan for another two weeks. So in this example, if you needed to roll over the loan for an additional four weeks, you'd pay an extra $180 in fees on top of the $400 balance you still owe.

Why Do People Turn to Payday Loans?

Payday loans clearly aren't very borrower-friendly, so why do they exist? For some, it might be the only alternative they have, but it's at least a solution that solves a temporary gap.

If you need to borrow money for an emergency bill or other urgent expense and your credit is poor, you may not be able to get approved for a personal loan with a more reasonable interest rate. And if you don't have a credit card or other ways of accessing cash, you may feel backed into a corner. Payday loans are easy to qualify for, so they are one of few viable options available in these scenarios.

How Installment Loans Work

Installment Loan Repayment Schedule: What To Expect

As their name implies, installment loans are repaid over time in equal monthly installments. You'll know from the get-go exactly how much you're expected to pay, which makes budgeting easier.

When you apply for a personal loan, the lender will offer you a specific repayment term that corresponds to the amount of money you’re looking to borrow. The more money you borrow, the longer the repayment term you usually qualify for. 

You may be able to choose from different payment terms to find the best option for your budget. If you can afford to pay an installment loan off quickly, you’ll spend less on total interest.

What Is the Typical APR on an Installment Loan?

The typical installment loan has an APR ranging from 6% to 36%. That's a wide range, and where you'll fall in that range depends on your credit score. Lenders view borrowers with higher scores as lower-risk, so they offer them lower interest rates than those with less-than-solid credit profiles. 

Beyond your credit score, the type of installment loan you choose can impact your APR. If you take out a secured loan that’s backed by collateral, such as a bank account or asset like a home or car, you’ll typically pay a lower interest rate than if you borrow with an unsecured loan.

When Is an Installment Loan a Better Option Than a Payday Loan?

An installment loan is usually a better option than a payday loan across the board, since even at the high end of the APR range installment loans cost much less. That said, there are some particular situations where an installment loan could better meet your needs. These include:

• You need to borrow a larger amount of money, since payday loans are capped at around $1,000.

• You need a longer amount of time to repay the loan, vs. payday loans which require full repayment by your next payday.

• You want predictable payments, with equal installments every month. This predictability can make installment loans easier to incorporate into your budget.

How Payday Loans and Installment Loans Compare

Here’s how payday loans and installment loans stack up, beyond the basic differences in structure.

Total Repayment Cost

• Payday loans: Higher APRs and the risk of rollover fees if you can't repay the full amount by your next payday

• Installment: Significantly lower APRs, but you’ll be paying the loan back over a longer period of time, so you could pay more in total interest

Which Loan Is More Likely to Lead to a Debt Cycle?

Both types of loans can lead to a dangerous cycle of debt if you aren't able to repay the money you borrowed by the agreed-upon due dates. However, payday loans can be especially risky due to the strain of repaying the entire lump sum in a short amount of time. With installment loans, you have more breathing room for repaying the money you borrow.

If you repeatedly roll over your payday loan repayment, you can end up in a costly trap where you owe more and more money on top of the principal you borrowed. That's not to say that you won’t be charged extra fees if you fall behind on an installment loan, but the amount is usually lower and operates on a different timeline.

Credit Score Impact

Both payday loans and installment loans can hurt your credit if you don’t make repayments. Lenders can sell your debt to a third-party collection agency which will seek repayment, and this results in a negative entry on your credit report.

But with installment loans, there’s the potential upside of actually helping your credit. Many lenders report your loan repayment to the credit bureaus, which can help boost your credit score. Payday lenders usually don't report positive payments, on the other hand.

Hidden Risks People Don't Consider

With both payday loans and installment loans, there are some lesser-known risks worth knowing about to prevent unpleasant surprises:

• If lenders attempt an auto withdrawal to collect your repayment and you don't have enough money in your account, you could be hit with costly overdraft fees

• Lenders may sell your debt to collection agencies if you don't repay the money you borrowed. Not only does this lead to a negative mark on your credit report, affecting your credit score, but you’ll also still be on the hook for repayment.

• State regulations vary. Payday loans aren't available in every state, and some states have specific borrowing caps for both payday and installment loans. Make sure you know the rules in your state before taking out a loan.

Payday Loan vs. Installment Loan: How To Decide

You might consider a payday loan if:

• No cheaper alternatives are available

• You can repay it in full within two weeks.

• You only need to borrow a small amount of money.

• There's no risk of needing to roll over the repayment date.

You might consider an installment loan if:

• You need to borrow more than $500.

• You need more time to repay.

• You want fixed payments rather than repaying in one lump sum.

• Your credit score is high enough to qualify, since even at the high end of the APR range you’ll likely pay less than with a payday loan.

Before choosing either option, consider these alternatives:

• Employer paycheck advances: You may be able to get early access to your paycheck by going through HR

• Credit union small-dollar loans: Credit unions are known for offering reasonable interest rates compared to other lenders.

• Payment plans with bill providers: It’s worth reaching out to creditors, utility companies and other individuals you owe money to. They may be willing to delay your payment date or come up with a more workable repayment plan.

• Earned wage access options: Services like MoneyLion Instacash^® can get you early access to a portion of your earned wages with 0% interest or mandatory fees*. 

FAQs

Can you get an installment loan with bad credit?

You may be able to get an installment loan with bad credit. Some lenders cater to lower-credit borrowers, though you may pay a higher interest rate. Check if a lender has a minimum credit score requirement before applying.

Is a payday loan ever cheaper than an installment loan?

A payday loan usually isn’t cheaper than an installment loan due to the higher interest rates and minimum loan terms. If you need to borrow a very small amount of money for a very short period of time, it’s possible the total cost of a payday loan could be lower, but, again, this typically isn’t the case.

Do installment loans hurt your credit score?

Installment loans can hurt your credit score if you don't make repayments. In that case, the lender could sell your debt to a collection agency, which would lead to a negative mark on your credit report. When you apply for an installment loan, the lender also performs a hard credit check, which can result in a small, temporary dip to your score.

Sources:

• Consumer Financial Protection Bureau (CFPB). 2024. "What is a payday loan?"

• Debt.org. "Personal Credit & Types of Consumer Loans."

• Federal Reserve Bank of St. "How Payday Loans Work."

• CFPB. "What does it mean to renew or roll over a payday loan?"