Personal Installment Loans Are Crushing Their Payday Counterparts
Born from the chaos of the 2008 economic crisis and with its creation authorized by the Dodd-Frank Act, the Consumer Financial Protection Bureau has had its sights fixed on payday lenders since at least 2013. After approximately two years of research, including soliciting complaints from payday loan borrowers, the CFPB released a report proposing new regulations for the payday lending industry in 2015. The final draft of the proposed rules was released a year later; the final rule was issued in October 2017. Throughout the process, the proposed regulations have been opposed by payday lenders, the National Credit Union Administration, the Independent Community Bankers of America and numerous members of the U.S. Congress. Because the actions of the CFPB were publicly supported by President Obama and virtually the entire Democratic Party, payday lenders started preparing for what appeared to be inevitable and turned their focus to personal installment loans — which have been increasing in popularity and are rapidly overtaking payday loans.
Why Are Personal Installment Loans Overtaking Their Payday Counterparts?
To understand why personal installment loans are increasing in popularity, it might be helpful to explain the differences between payday loans and installment loans as well as the different types of installment credit. Payday loans are typically quick; most lenders only require a reliable source of income, a checking account in good standing and an acceptable proof of identity. These loans are normally due on the borrower’s next payday, so the average loan term is about 15 days. Borrowers give the lender a postdated check for the full loan amount plus the associated fees; alternatively, borrowers may sign an agreement that allows the lender to collect the payment electronically from their bank account. Because these are short-term loans, when the percentage rate is annualized, the APR is normally 400 percent or more.
The CFPB and others have criticized the brevity of payday loans and the requirement for borrowers to pay off the loan in a lump sum. Some borrowers found that they could not repay the loan when it was due and still have money left to buy food, pay rent or cover living expenses. Most lenders would allow them to pay just the fee and renew the loan. This could lead to borrowers becoming mired in a cycle of debt that could last for many months. Sometimes, borrowers would obtain a loan from a different payday lender to pay off the initial loan, but they often found that all that had changed was the lender to whom they owed money.
Installment credit works quite differently, according to Investopedia.com. If you have ever financed a car, you have used installment credit. The basic concept is that the loan and associated interest is repaid through monthly payments that are more or less equal. The amount of the payments depends on the loan amount, the number of months that you will need to make payments and the interest rate, including any associated fees. The monthly payments are predictable, and borrowers always know exactly how long they will be in debt to repay the loan.
Long term installment loans are typically those that stretch the payments over more than two years, but some experts believe that anything under five years should be considered a short-term installment loan. Installment loans may be secured by collateral; mortgages and car loans are examples of secured loans since the lender can take the collateral if the borrower defaults on the loan. Personal installment loans, however, are typically unsecured; borrowers do not pledge collateral, and the lender has only the borrower’s promise that he or she will make timely payments.
Most unsecured personal installment loans require borrowers to pay off their loans in no more than 24 months. Some lenders limit the repayment term to as little as six months, while others will not approve loans with terms longer than 12 months. The repayment term depends on the lender’s policy, the amount borrowed and other factors. Many lenders offer installment loans designed for people with bad credit, but other lenders may review a borrower’s credit history before deciding whether to approve the loan and the interest rate that will be charged.
What Are the Advantages to Choosing Installment Credit Instead of Payday Loans?
As a rule, the more risk that a lender must take, the more he will charge for interest and/or fees. Payday loans have an extremely high rate of default, so lenders must charge higher rates to offset the risk that a borrower will never repay the loan. The risks involved also explain why lenders often do not offer payday loans for more than $500 or so.
Personal installment loans are typically less risky than payday loans. For many consumers, it is much easier to budget for a monthly payments on an installment loan than to try to set aside the full amount of a payday loan. Because people tend to find it easier to make payments on personal installment loans, they tend to be less likely to default on these loans. The lower default rate also allows lenders to offer installment credit with higher loan limits than payday loans.
Long term installment loans can be a good way for people with bad credit to raise their scores; most lenders will report the borrower’s payment history to one or all of the credit bureaus. Conversely, late payments can lower the borrower’s scores. In recent years, many lenders have started reporting payment histories to the credit bureaus on short-term installment loans as well. Since credit scores take into account the variety of credit types that borrowers have, a mix of short-term installment loans, credit cards and long term installment loans can often contribute to an improvement in the score.
Choosing a Lender for Personal Unsecured Loans
When choosing the lender or lenders to whom you want to apply for in-person or online installment loans, it is important to select wisely. Beware of any lender who is not willing to provide you with full disclosure of the interest rate, repayment term and standard fees, including origination or potential late fees. Keep in mind, however, that you may need to supply your personal information before the lender can determine your interest rate or loan amount, which must first be determined before the lender can tell you how much your monthly payments will be.
Watch out for add-ons that can increase your indebtedness. For example, some lenders sell insurance that will cover your payments if you become unemployed or physically unable to work. Credit life will repay your loan in the event of your death. However, the lender is the beneficiary of these insurance policies rather than you or your family, and since these policies can be expensive, most borrowers do not feel that they are worth the cost.
Learn all that you can about the different types of credit products available to you so that you know the advantages and disadvantages of each type. A good place to start is the Personal Money Store, where you can find helpful articles about long term installment loans, short-term installment loans and payday loans as well as answers to many of your questions about personal credit.