Payday Loans Vs Personal Loans: What’s The Difference?

If you need money to cover an emergency, there are several ways you can borrow it.

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 come with hidden fees. This makes it very easy to get stuck in a debt trap where it becomes very difficult to pay off your loan even if you only borrowed a small amount initially.

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. For this reason, personal loans are often used to consolidate debt and are a much safer way to access credit.

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

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 the cost of unforeseen bills or other financial obligations.

These loans can differ greatly. Payday loans are generally used to borrow small amounts of money until your next paycheck and are very easy to organize. You will not need any collateral for these loans and they can be quite expensive. For this reason, they are often considered predatory loans as they carry extremely high interest rates, disregard the borrower’s repayment capacity, and have hidden provisions that charge borrowers 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 will normally need to provide them with proof that you will eventually be able to repay the loan. Personal loans normally involve much larger amounts of money than payday loans, but you will have a lot more time to pay off that money. The interest rates and fees for a personal loan are much lower than for a payday loan, so the overall cost of borrowing is likely to be much lower.

How payday loans work

It is normally very easy to get a payday loan. You can walk into a payday lender’s office and walk out with a loan. You won’t have to give the lender anything to secure the loan like you would with a pawnshop. Instead, the lender will normally ask you for permission to withdraw money electronically from your bank, credit union, or prepaid card account. Sometimes the lender may ask you to write a
check the repayment amount the lender will cash in when the loan matures.

Payday loans can be expensive. Payday lenders charge very high interest rates: up to 780% Annual Percentage (APR), with an average loan standing at almost 400%. Most states have usury laws that limit interest charges from 5% to 30%. However, payday lenders enjoy exemptions that allow their high interest. 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 ban extremely high cost payday loans. Seven states – Maine, New Mexico, Ohio, Oklahoma, Oregon, Virginia, and Washington – have imposed measures, such as term limits, fee limits, or the number of loans per borrower who offer some protection to consumers.

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

How personal loans work

To get a personal loan, you need to apply from a lender. Again, this could be a bank, credit union, or online personal lender. Usually, you must first complete an application. The lender reviews it and decides whether to approve or deny it. If approved, you will receive the terms of the loan, which you can accept or decline. If you accept them, the next step is to finalize your loan documents.

When this is done, the lender will fund the loan, which means you will pay the proceeds. Depending on the lender, these can arrive by direct deposit to your bank account or by check. Once the loan is funded, you can use the money however you want.

Personal loans can be secured or unsecured. A secured personal loan is a loan that requires some form of collateral as a condition of borrowing. For example, you can get a personal loan with cash, like a savings account or certificate of deposit (CD), or with a physical asset, like your car or boat. If you don’t repay the loan, the lender might keep your collateral to pay off the debt.

Personal loans can also be found online. Many lenders offer personal loans through their websites. You can apply electronically, get a decision in minutes, and in some cases, get financing within 24-48 hours of loan approval. Using a simple online personal loan calculator can help you determine the type of amount and interest rate that best suits your budget.

Lenders may have different credit score, income, and debt-to-income ratio requirements that are acceptable to be approved for a personal loan. This can help you choose the loans that best match your credit profile and financial profile.

Key differences

There are several key differences between payday loans and personal loans when it comes to dealing with emergency spending:

• Cost. Payday loans generally have much higher interest rates than personal loans and can impose hidden fees and charges on you.
• Accessibility. Payday loans can be easier to arrange, especially for people with limited credit history and other financial issues. With some payday lenders, you can even get a loan without a bank account 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 appear on your credit report. If you take out a personal loan and make your payments on time, your credit score will increase, which will help you qualify for better loans and interest rates in the future.

In almost all situations, a personal loan will be more expensive than a personal loan. If you need the money urgently, the best thing you can do is apply for a personal loan if you can qualify. Then, if you don’t qualify, you may want to consider other options. Even so, it may be best 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?