Payday Loans vs. Personal Loans
8 Min Read
Americans borrow money in many ways. Payday loans and personal loans are popular options, especially for borrowers with bad credit. Both are unsecured – you can get them without posting collateral – and can quickly provide you with cash as soon as the same day. They both charge interest, and you must repay them on a specific schedule. Either one can provide much-needed funds to cover cash shortfalls and financial emergencies.
But as we will show, their differences significantly outweigh their similarities. We’ll help you understand how payday and personal loans work so you can make an informed decision before e-signing a loan agreement.
Table of Content
- Overview of Payday Loans vs. Personal Loans
- How a Payday Loan Works
- How a Personal Loan Works
- Summary Comparison: Personal Loans vs. Payday Loans
Overview of Payday Loans vs. Personal Loans
Personal loans are available from online lenders and conventional financial institutions (i.e., banks and credit unions). The law requires personal loan lenders to check whether you can reasonably expect to repay the loan before letting you borrow. Personal loans are usually much larger than payday loans, and you can pay them off over months or years. They are also less costly than payday loans.
Payday loans are small and expensive. Their purpose is to tide you over until your next paydate. You repay them in full on your paydate, typically in one to four weeks. Payday loan lenders do not perform credit checks, so these loans won’t impact your credit score (unless they go into collection). Borrowers don’t have to prove they can repay the loan, only that they have a steady income source.
How a Payday Loan Works
You can get a payday loan online or by visiting a payday loan storefront. These loans do not require collateral, but to help ensure repayment, the lender will arrange to withdraw money from your bank account electronically on the paydate. Storefront lenders may instead give you the option of writing a check postdated for your next paydate.
Applying For a Payday Loan
The storefront type of payday loan is the fastest. You walk into the establishment, submit some paperwork, and walk out with cash. Online payday loans are more convenient since you can apply from the comfort and safety of your own home. If the lender approves your loan, it will wire the proceeds directly to your bank account.
An extra level of convenience is available through online loan networks. These are lender-finding agents to which you submit a loan request form. The agent prequalifies your request by collecting various data items that may include the following:
- Age (you must be at least 18 years old)
- Amount requested
- Loan reason
- Address and how long you lived there
- Email address
- Phone number
- Whether you own or rent
- Income source
- How long you’ve worked in your current job
- Paydate frequency and next paydate
- Military membership
- Employer information
- Driver’s license or state ID number
- Social Security number
- Bank account info
- Receive pay by check or direct deposit
- Credit score
- Amount of unsecured debt
- Whether you own a paid-off car
- Permission to share your request with lenders
The agent will process your request and share it with direct lenders on its network. You can then select an offer and complete the application process. Offers must include all the loan terms, including amount, cost, repayment date, and rollover procedures.
You e-sign the loan agreement after final approval. Expect the funds to arrive in your bank account typically on the next business day, if not sooner.
Payday Loan Cost
You should understand in advance that payday loans are expensive, with annual percentage rates (APRs) averaging around 400% (although some may exceed 700%). These APRs may indicate predatory lending practices. Payday loans are usually not subject to a state’s usury laws, if any. However, 16 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 an outright ban on payday loans.
A payday loan’s small size (usually less than $1,000) and short term (one to four weeks) somewhat mitigate the high interest rate. For example, you might pay a $40 finance charge on a two-week, $225 payday loan, equivalent to an APR of about 463%.
A problem arises if you can’t repay the loan on time. According to the Consumer Financial Protection Bureau, 48% of borrowers must roll over payday loans multiple times. The lender rolls over your loan by adding the finance charge to your principal, assessing a new finance charge, and resetting the due date. Each rollover creates a larger finance charge that can lead to a debt trap – the chronic inability to repay the loan. This may lead to intercession by a collection agency or, in the worst case, bankruptcy proceedings. Some states limit the number of rollovers a payday lender may perform.
Pros and Cons of Payday Loans
Consider these pros and cons when deciding whether to take a payday loan.
- Payday loans do not require a credit check and therefore won’t impact your credit score
- These are speedy loans in which you can receive the funds potentially on the same day
- These loans charge high APRs of 300% to 700% or more
- You must be employed or regularly receive government benefits or alimony
- You must repay the loan and finance charge in a lump sum in one to four weeks
- These loans are usually limited to $1,000 or less
- Rollovers can send you into a debt trap with disastrous results
- Payday loans do not help you to build credit
- Payday loans are not available in all states
In sum, payday loans are expensive but easy to access despite poor credit. They are small loans that require repayment in one to four weeks, although you may roll over a payday loan (and incur additional costs).
How a Personal Loan Works
Personal loans fit into the broader category of installment loans, which feature regular personal loan monthly payments. The loan size, interest rate, and the months it takes to repay the loan determine your monthly bill. Some personal loan providers require borrowers to pay origination loan fees (typically 1% to 5%) to access the loan.
Applying For a Personal Loan
You can get personal loans at a bank, credit union, or online, directly or through a lender-finding agent. Online personal loan agents use networks similar to those for payday loans. In fact, many agents work with multiple types of loans – personal, paydate, auto title, student, etc.
If you use an online personal loan network, you’ll submit the same information as previously outlined for payday loans. Unlike payday lenders, personal loan providers check credit, which may affect your credit score. They also calculate your debt-to-income (DTI) ratio to verify that you can afford to repay the loan.
You may have to provide additional documents, such as pay stubs, tax returns, and bank statements, to prove your income. Most personal loans are unsecured, but secured ones are widely available. You can pledge various collateral types, including cash, CDs, stocks, bonds, or personal property (e.g., a vehicle, a boat, etc.). Typically, secured personal loans are easier to get and cost less than unsecured ones.
Personal Loan Cost
Personal loans charge less than payday loans. They are often capped at 36% for subprime borrowers but may be significantly less expensive for consumers with good credit. Loan amounts vary widely, from $500 to $35,000 or more. Loan terms run from three to 60 months or more. Origination fees, when present, typically top out at 5%.
You can use an online personal loan calculator to figure your total and monthly costs. For example, suppose you want a $10,000 personal loan with a five-year repayment term and an APR of 20%. A calculator will show you the monthly payment amount ($264.94) and the total interest cost ($5,896.32). You can save on interest by prepaying the loan – most personal loans do not penalize early repayment. If there is an origination fee, you may pay it in advance or roll it into the loan principal.
Many lenders require access to your bank account to withdraw monthly payments electronically. The lender will charge a late fee if you miss a payment or have insufficient funds in your bank account. Bank fees may also apply. Some loan agreements give the lender the right to call your loan if you miss a payment, meaning you must immediately repay the entire balance. If you take a secured personal loan and fail to pay on time, the lender may seize and liquidate your collateral to repay the loan.
Pros and Cons of Personal Loans
The pros and cons of personal loans differ from those of payday loans.
- You can get a relatively large personal loan, especially if you post collateral
- You can control your monthly payment amount by specifying the number of installments
- Interest rates usually top out at 36% for those with poor credit
- You can build credit by repaying your personal loan on time
- Personal loans require credit checks that may harm your credit score and even disqualify your application
- Expect penalties for late or missed payments, ranging from extra fees to early cancellation
- You may have to pay an origination fee of 1% to 5%
- Your credit history and score determine your APR, which disadvantages subprime borrowers
The bottom line is that personal loans are small-to-large installment loans with reasonable interest rates and potentially long repayment terms.
Summary Comparison: Personal Loans vs. Payday Loans
The following chart summarizes the differences between payday and personal loans.
|Characteristic||Payday Loans||Personal Loans|
|Cost||Expensive interest rates and fees||Lower costs|
|Loan Size||For small-sized loans||For larger loans|
|Access||You do not have to prove you can repay the loan||You must prove you can repay the loan|
|Repayment Term||Repay on the next paydate in one to four weeks||Repay in fixed installments from three months to five or more years|
|Fees||Hidden charges for rollovers||No hidden charges, but it may have a high origination fee|
|Credit Score Impact||Not reported to credit bureaus, no score impact||Reported to credit bureaus so may impact scores|
Borrowers may also want to consider a credit card cash advance or perhaps seek out credit union payday alternative loans instead of taking high-cost payday loans.
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