Payday Loans vs Personal Loans: What’s the Difference?

If you need money for an emergency, you can borrow it in a number of ways.

One is a payday loan. This type of loan is easy to apply for but can be very risky. Payday loans charge high interest rates and often have hidden fees. This very easily gets you into a debt trap where it becomes very difficult to repay your loan, even if you only borrowed a small amount to begin with.

Another option is a personal loan. These loans are a bit more complicated to apply for, but have much lower interest rates than payday loans. Because of this, personal loans are commonly used for debt consolidation and are a far safer way to get credit.

Here’s what you need to know about the differences between these loans and how to decide which one is best for you.

The central theses

  • If you need money for an emergency, you can borrow it in a number of ways. One is a payday loan. This type of loan is easy to apply for but can be very risky. Another option is a personal loan. These loans are a bit more complicated to apply for, but have much lower interest rates than payday loans.
  • With a simple online personal loan calculator, you can determine what type of payment amount and interest rate best suits your budget.
  • Payday loans are almost always more expensive to borrow than personal loans, and also riskier. If you’re eligible for a personal loan, this option lets you borrow more money, pay it back longer, and charge less interest.

Payday Loans vs. Personal Loans: An Overview

Payday loans and personal loans have some similarities. With both loans, you borrow money that must be repaid with interest at a later date. Both loans can be used to cover emergencies and to cover unexpected bills or other financial obligations.

These loans can vary significantly. Payday loans are generally used to borrow small amounts of money until the next paycheck and are very easy to arrange. These loans do not require collateral and can be very expensive. For this reason, they are often viewed as predatory lending as they have extremely high interest rates, do not consider a borrower’s ability to repay, and contain hidden provisions that charge the borrower additional fees.

Personal loans are a much broader category. This loan is usually offered by a bank, credit union, or online personal lender, and you usually have to show them proof that you can eventually repay the loan. Personal loans are usually for much larger amounts of money than payday loans, but you have much more time to repay that money. The interest rates and fees on a personal loan are much lower than a payday loan, so the overall cost of borrowing is likely to be much lower.

warning

Payday loans can charge high interest rates – up to 400% – and hit you with hidden fees.

How payday loans work

It is usually very easy to get a payday loan. You can walk into a payday lender’s office and walk out with a loan. You don’t have to give the lender anything to secure the loan like you would at a pawn shop. Instead, the lender will usually ask you for permission to electronically withdraw funds from your bank, credit union, or prepaid card account. Sometimes the lender may ask you to write one
Check the repayment amount that the lender will collect when the loan matures.

Payday loans can get expensive. Payday lenders charge very high interest rates: up to 780% of the annual percentage rate (APR), with an average loan being close to 400%. Most states have usury laws that limit interest charges to between 5% and 30%. However, payday lenders fall under exceptions that take into account their high interest rates. Sixteen states — Arizona, Arkansas, Colorado, Connecticut, Georgia, Maryland, Massachusetts, New Jersey, Montana, New Hampshire, New York, North Carolina, Pennsylvania, South Dakota, Vermont, and West Virginia, and the District of Columbia — have outright bans for extremely expensive payday loans. Seven states – Maine, New Mexico, Ohio, Oklahoma, Oregon, Virginia and Washington – have introduced measures such as term limits, fee caps or the number of loans per borrower that offer some protection to consumers.

Payday loans say their high interest rates are misleading because if you pay off your payday loan on time, you will not be charged high interest. That may be true in some cases, but according to the Consumer Financial Protection Bureau (CFPB), 80% of payday loans are rolled over multiple times, indicating that the majority of these loans are not repaid on time.

consolidate debt

You can use a personal loan to consolidate debt. With good credit, you can often take out a personal loan at a lower interest rate than you would pay with your credit card.

How personal loans work

To get a personal loan, you need to contact a lender. Again, this could be a bank, credit union, or online personal lender. As a rule, you first fill out an application. The lender reviews it and decides whether to approve or reject it. If approved, you will be presented with the loan terms, which you can accept or decline. If you agree to them, the next step is to complete your loan documents.

When that’s done, the lender funds the loan, which means they pay you the proceeds. Depending on the lender, these may come through a direct deposit into your bank account or by check. After the loan is funded, you can use the money as you see fit.

Personal loans can be secured or unsecured. A secured personal loan is a loan that requires some form of security as a condition of borrowing. For example, you can secure a personal loan with cash such as a savings account or a certificate of deposit (CD), or with a physical asset such as your car or boat. If you default on the loan, the lender can keep your collateral to pay off the debt.

You can also find personal loans online. Many lenders offer personal loans through their websites. You can apply electronically, receive a decision in minutes and, in some cases, receive funding within 24 to 48 hours of loan approval. With a simple online personal loan calculator, you can determine what type of payment amount and interest rate best suits your budget.

Lenders may have different requirements when it comes to the creditworthiness, income, and debt-to-income ratio that are acceptable for personal loan approval. This can help you narrow down the loans that best fit your credit and financial profile.

main differences

There are several key differences between payday loans and personal loans when it comes to covering emergency expenses:

  • costs. Payday loans generally have much higher interest rates than personal loans and can hit you with hidden fees and charges.
  • Accessibility. Payday loans can be easier to arrange, especially for people with limited credit histories and other financial challenges. With some payday lenders, you can even get an unbanked loan as long as you have a prepaid card account.
  • Impact on your credit score. Most payday lenders do not report to the credit bureaus. This means that only personal loans will appear on your credit report. Taking out a personal loan and paying it on time will increase your credit score, which will help you qualify for better loans and interest rates in the future.

In almost every situation, a payday loan will be more expensive than a personal loan. If you need emergency money, it’s best to apply for a personal loan if you can qualify. If you don’t qualify then you can look at other options. Even then, it may be better to spend money on your credit card, ask your employer for overtime, or borrow money from family and friends.

Is a Personal Loan a Better Alternative to a Payday Loan?

In general, a personal loan is cheaper than a payday loan. Lower personal loans give a borrower more time to repay a loan than a payday loan, and most credit unions offer APR personal loans that are comparable to credit cards, which still charge lower interest rates than payday loans.

Are Payday Loans Hard Or Easy To Repay?

Payday loans are sometimes more difficult to repay than a traditional loan because the lender has not verified your ability to repay before lending you money. Payday lenders generally don’t evaluate your debt-to-income ratio or consider your other debts before making a loan to you.

Do Payday Loans Help Your Credit Score?

Probably not. Payday loans are generally not reported to the big three national credit bureaus, so they are unlikely to affect your credit score. Unless you don’t repay the loan on time and are referred to a collection agency: that will damage your credit rating.

The final result

Payday loans are almost always more expensive to borrow than personal loans, and also riskier. If you’re able to qualify for a personal loan, this option lets you borrow more money, give you more time to pay back, and charge you a lower interest rate. If you need some emergency cash, the first thing you should do is apply for a personal loan.

About Stephanie McGehee

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