If you need some financial help, payday loans and personal loans are two ways to borrow money. You typically don’t need any collateral for either loan, and you can use the money any way you like. Payday loans work well for quick cash – but they can be very dangerous and very expensive in the long run. Personal loans work well for larger expenses. And when compared to payday loans, are a far less dangerous option.
There are also quite a few differences between the two loans. And depending on your financial situation, there are advantages and disadvantages to both. Let’s take a look at how these loans stack up against one another.
How Payday Loans Work
A payday loan, sometimes referred to as a cash advance or a check loan, is an unsecured (read: no collateral necessary), short-term loan with high fees that lets you borrow a small amount of money from a payday lender. Depending on where you live, you may be able to apply for a payday loan online or at a brick-and-mortar business. Visit the National Conference of State Legislatures to review the payday lending regulations in your state.
A payday loan is one way to get a modest amount of money (usually $500 or less) fast, sometimes as quickly as an hour. Payday loans can cover unexpected expenses like small medical bills or car repair bills.
What are the qualifications?
To qualify, you must be at least 18 years old, have a valid government ID and provide the lender with proof of income. Because the bar to qualify for a payday loan is lower than it would be for a personal loan or a credit card, it’s a lot easier to get approved.
What are the terms?
So far, so good, right? Well, this is where you need to pay close attention.
Payday loans are generally repaid in full either in 2 – 4 weeks or whenever you anticipate receiving your next paycheck. You can pay off the loan with a postdated check or by a preauthorized direct debit.
If you don’t pay your loan by the due date, the lender can cash your check or withdraw the money from your account – even if you don’t have the funds to repay it. This can trigger fees for insufficient funds from your bank, causing you more financial stress.
Payday loans are one of the most expensive financing options available to borrowers. Standard fees like origination fees or maintenance fees can run high, anywhere from $10 – $30 for every $100 borrowed. That amounts to an annual percentage rate (APR) of approximately 400% for a 2-week loan. Just for comparison’s sake, a credit card’s APR is around 12% – 30%. And, in some states, interest rates are charged on top of the standard fees.
What is the payday loan cycle?
Some states let you roll your payday loan over to the next month if you can’t pay it off by its original due date. While the extension may bring some relief, it will also bring more fees and potentially create a cycle of debt that’s hard to break.
Even if you roll over your loan, you must pay its original fees by the due date. Your lender will give you another 2 – 4 weeks to pay off the loan plus its newly added fees (which may include a rollover fee).
The majority of payday loan borrowers end up rolling over their loan multiple times, accruing fees with each rollover and adding more debt to what they originally borrowed.
Unless you’re confident you can pay the loan back by its due date, you may fall into a debt trap with a payday loan.
If you’re uncertain about your ability to repay a payday loan on time, a personal loan may be a better option for your financial situation.
How Personal Loans Work
A personal loan (aka an installment loan) is usually an unsecured loan that allows you to borrow up to $50,000 or more from a lender. A personal loan has a fixed interest rate and borrowers make fixed monthly payments over the life of the loan.
Because most personal loans are unsecured, they are typically more flexible than secured loans. They can be a great way to finance one-time expenses like weddings, larger medical bills or debt consolidation.
After a lender approves your loan application, you receive the loan in one lump sum. Interest on the loan starts to accrue immediately, and your repayment term begins. Carefully calculating how much you need before applying for a loan can help protect you from paying more in interest than you need to.
What are the qualifications?
To qualify, you’ll need a credit score in the mid-600s or higher to get favorable terms (some lenders will work with borrowers whose credit scores are in the lower ranges), a debt-to-income (DTI) ratio of 36% or lower (some lenders will accept a DTI or 50%), proof of income and a solid record of paying your bills on time.
A lender will do a hard check (aka hard pull) of your credit report to review your creditworthiness and will look at your income and assets to determine whether you can afford to repay the loan.
What are the terms?
Personal loans are generally repaid with fixed monthly payments in 2 – 7 years. They’re a great option if you have a stable income. And because the monthly payments never change, it’s easier to fold them into your budget.
Unsecured personal loans typically have higher interest rates than secured loans, but they are much lower than payday loan interest rates and can even be lower than credit card rates. The interest rates on personal loans generally range from 5% – 36%.
What are the advantages and disadvantages of personal loans?
Like all loans, there are advantages and disadvantages to personal loans. You can see some of the major pluses and minuses in our list of pros and cons.
You can often get the money quickly, in 7 – 10 days or as little as 24 hours.
Unsecured loans generally offer lots of flexibility when it comes to what you can spend your money on.
Fixed interest rates make payments predictable, and the fixed payments are spread out over time, which can make the loan easier to budget for and manage.
Personal loans tend to have lower interest rates than payday loans.
Payday loans may have high fees, but personal loans have many fees, including an origination fee, an application fee, a late payment fee and maybe a prepayment fee if you repay your loan early.
Even if you don’t start using the money as soon as you receive it, interest accrues from day one.
Did you borrow more money than you needed? Tough luck. You have to repay the entire loan amount plus interest. If you didn’t borrow enough money, you’ll have to go through the application process all over again.
Differences Between Payday Loans and Personal Loans
There are two major differences between payday loans and personal loans: how much you can borrow and the loan terms. But let’s take a look at some other differences in more detail.
|Payday Loans||Personal Loans|
|Usually $500 or less, repaid in 2 – 4 weeks in one lump sum||Usually up to $50,000, repaid in 2 – 7 years in monthly installments|
|Fees and interest rates are extremely high, higher than any other financing option||Fees and interest rates can be lower than payday loans|
|Lenders don’t typically check your credit score to see if you qualify.||Lenders will check your credit score to see if you qualify and set your loan terms.|
|Usually aren’t reported to credit bureaus, which won’t help build your credit history||May be reported to credit bureaus, which may help build your credit history|
Which Loan Is Right for You?
To decide if a payday loan or personal loan is better for you, you’ll have to examine the loans through a personal lens. Look at your current financial situation, why you want to borrow the money and how you plan to repay it. Let’s look at a quick summary of each option.
Payday loans are good for smaller, surprise expenses but come with high fees. Because lenders don’t look at your credit score to qualify you for a payday loan, a low credit score shouldn’t prevent you from qualifying for a payday loan – but it should be a last resort.
If the amount you need is small and you know you can pay it back by the time your next paycheck rolls around, it may be a better option than a personal loan.
But a payday loan may not be a good idea if you aren’t sure you can repay it by the due date and may need to roll the loan over. Rolling over your debt will pile new fees on top of what you owe. It can put you in a worse financial situation than you were in before you borrowed the money.
Personal loans are good for big one-time expenses and are repaid over time with fixed monthly payments, plus interest. A personal loan may be a better option than a payday loan if you need to spread out payments over time.
Lenders will check your credit score to see if you qualify for a personal loan. If you have a low credit score and a spotty credit history, it will likely be harder to qualify for a personal loan.
Keep in mind that when a lender checks your credit, it can affect your credit score. If you can’t afford the temporary dip in your credit score, a payday loan may work better as a quick, last-resort option.
Alternatives to Payday Loans and Personal Loans
There are plenty of alternatives out there when it comes to borrowing money.
Lenders will look at your income to see if you qualify for a loan. Except for the payday alternative loan, lenders will also look at your credit report and debt.
- Payday alternative loan (PAL): PALs are offered by credit unions. You can borrow up to $2,000 and repay it in 1 – 12 months. PALs have much lower fees than payday loans and are regulated by the National Credit Union Administration.
- Home equity loan: A home equity loan lets you borrow a lump sum of money against the equity in your home. You must have at least 15% equity in your home to qualify. It’s a secured loan (which means the loan is backed by your home) and the interest rate on the loan is fixed.
- Home equity line of credit (HELOC): HELOCs aren’t quite the same as home equity loans. Like a home equity loan, you borrow against your home’s equity. Instead of receiving the loan as a lump sum, you get a line of credit to borrow from, like a credit card. HELOCs have variable interest rates, and you must have at least 15% equity in your home to qualify.
- Credit card: Credit cards are revolving credit accounts. You use the card up to its credit limit and pay the minimum or entire balance every month. Credit card interest rates are typically higher than the interest rates for personal loans, but you only pay interest on what you borrow.
- Personal line of credit: A personal line of credit is an unsecured loan that behaves a lot like a credit card. With a personal line of credit, there is a draw period. During the draw period, you can withdraw funds. At the end of the draw period, the loan enters the repayment period. The interest rates for personal lines of credit are lower than credit cards but usually higher than personal loans, home equity loans and HELOCs.
Payday or No Way?
If you need to borrow some emergency money, you’ve got two options: a payday loan or a personal loan. But a payday loan will almost always cost you more money, putting you at risk of getting trapped in a relentless cycle of debt.
A personal loan allows you to borrow the money you need, gives you a longer period of time to repay it and comes with a lower interest rate than a payday loan. If your credit score and credit history meet the mark, it may be better to apply for a personal loan.
Consumer Financial Protection Bureau. “What Is a Payday Loan?” Retrieved April 2022 from https://www.consumerfinance.gov/ask-cfpb/what-is-a-payday-loan-en-1567/
Consumer Financial Protection Bureau. “CFPB Finds Four Out Of Five Payday Loans Are Rolled Over Or Renewed.” Retrieved April 2022 from https://www.consumerfinance.gov/about-us/newsroom/cfpb-finds-four-out-of-five-payday-loans-are-rolled-over-or-renewed/
National Credit Union Administration. “Payday Alternative Loan Rule Will Create More Alternatives for Borrowers.” Retrieved April 2022 from https://www.ncua.gov/newsroom/press-release/2019/payday-alternative-loan-rule-will-create-more-alternatives-borrowers