Making Sense Of Money

Instalment Loans vs Payday Loans

Instalment loan vs payday loanAccording to web definition an instalment loan is a loan that is repaid over an agreed period time via a set number of scheduled payments or instalments (normally at least two). The actual term of loan may be as little as a couple of months or as long as 30 years.

That means that most “traditional” loans fall into the category of instalment loans –doorstep loans, personal loans, even mortgages are included. What it excludes are loans that are paid off in a single payment or open ended credit such as credit cards or overdrafts.

These days though, the term is particularly associated with small (ish), short term loans that are being marketed as alternatives to the controversial payday loan and it’s these type of loans we’re going to look at in this article.

Payday loans have received and continue to be subject to bad press but it’s a growing market – you only have to look around to see just how many companies there are in the UK today fighting for your business. The way a payday loan works is that the lender is able to transfer a small sum of money into the borrowers bank account almost immediately, often within hours and almost always the same day. The size of the loan can vary to suit, typical size from a couple of hundred pounds and up to a thousand or so (depending on eligibility and need). When the loan is agreed so is the repayment term which will be set at a convenient date to the borrower to coincide with the next payday … hence the name! So what you have, in effect, is an advance on your wages – the loan simply needs to be paid back, in full and plus interest, the next time you are paid. Sounds simple, so why all the controversy?

From a lenders point of view a short term loan involves, low administration costs, a small sum of money, a single in full repayment set up by direct debit in advance plus a high interest rate results in a minimal risk and high profits – this is why lenders are falling over themselves to lend in this manner.

From a consumers angle it’s an instant fix to a financial problem – a simple solution to a cash flow problem. This makes it particularly attractive to those without savings, on lower incomes or with a less than perfect credit rating whereby access to alternative lending solutions (overdraft facility for example) is limited.

Here lies the problem – the payday loan is applied for and received. The consumer is happy because they have found a way round a financial problem but then it comes time to pay it back … in full and plus interest. This payment is taken straight out of the bank the day the next salary is paid in and that invariably means a huge chunk of money off your monthly income and hence that the borrower is going to have a very tight budget and, more often than not, will not have enough to see them through the month again … guess what happens then … you’ve got it, another payday loan but what happens the following month then … need we say more.

Don’t get us wrong, payday loans do have their place in society and if they’re used as they’re intended they can provide a real benefit but in many cases they’re not and that’s why you hear the horror stories.

The market for this kind of finance is massive and growing and that’s why lenders have taken the initiative to try and provide the same fast fix finance with a more affordable repayment structure and that’s what is now associated with the term instalment loans.

From a consumers point of view the instalment loan sounds great in principle – the same simple application form, the same fast service with the added benefit of not having to repay in full but spreading the cost over 2, 3, 4 or sometimes as many as 12 monthly payments.

However, from a lenders point of view administration costs are higher, the loan may be larger, there is increased risk of default on instalments and therefore interest rates need to be higher to reflect this.

You need to look very closely at the cost of this form of borrowing, you will invariably be paying dearly for this service – check the representative examples of the various companies advertising instalment loans as an alternative to payday loans to give you an idea of just how much it will cost. These representative examples can be a little confusing but they will all tell you how much the total cost of the loan will be. They can vary a great deal – for example you may get a £200 loan over a 3 month period at a total cost of less than £300 but a £300 instalment loan spread over 9 months may result in a total repayment in excess of £850 for example – the longer the term and the larger the loan the greater the risk to the lender and that comes at a price to the consumer!

Again, used correctly the instalment loan can be really useful but shop around and always consult a professional financial advisor and always look for another way – sometimes a loan can seem an easy option or the only option but there’s often another way – family, employer, bank, selling unwanted items, tightening the belt etc. Payday loan or instalment loan … do you need to borrow at all?

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