Life is full of surprises. And sometimes, they come with unexpected costs.
When you need money for that urgent car repair or unexpected medical bills, the panic can cut deep. But during a financial emergency, a loan can help you cover your expenses until you’re back on your feet. Here, we’ll explain the difference between payday loans and personal loans, two popular borrowing options for when you need cash at a moment’s notice.
Also known as cash advances or check loans, payday loans give you access to cash on the spot. These short-term loans get their name from their quick turnaround period—they’re meant to help people cover time-sensitive financial obligations until their next paycheck.
You may be more familiar with personal loans, which usually come with a more rigorous application process. Additionally, personal loans typically have longer terms, lower interest rates, and are available for higher amounts than payday loans. Although they were originally introduced as a way to finance large purchases or emergency bills, the Chamber of Commerce reveals that there are now 21.1 million outstanding personal loans in the United States. With a combined balance of $156 billion, this makes them one of the fastest-growing categories of consumer lending products today.
Both of these lending products are unsecured, so you won’t forfeit any assets if you can’t make your payments. But that’s where the similarities end. Let’s dive into the four main differences between them.
1. How much money can you borrow?
Like most traditional loans, you can apply for personal loans at banks, credit unions, and online lenders. Depending on your credit history, state of residence, and other variables, some lenders will let you borrow between $1,000 and $50,000. Payday loans, on the other hand, can be found at certain financing companies, check cashers, and even online. They have a much smaller maximum amount than personal loans ranging in size from $100 to $1,000, depending on state legal maximums.
2. Which one gives you better interest rates?
With personal loans, your credit score will be the biggest predictor of your interest rates. A higher credit score gives you a lower annual percentage rate (APR). But personal loans are available for those with less than perfect credit, which could make them a smart option for refinancing your credit card debt (or other high-interest debt) or for purchasing high-ticket items, such as home appliances.
By comparison, interest rates for payday loans are cut-and-dried. Most lenders charge a flat-rate fee of $10 to $30 on every $100 borrowed, although rates vary by state. According to the Consumer Financial Protection Bureau, a $15 fee translates to an APR of about 400%.
3. How do you apply?
Applying for a payday loan is quick. You must be at least 18 years old and have:
A valid ID
Your bank account information
Proof of employment
Upon approval, you can receive your money immediately.
Unlike payday loans, personal loans take from 24 hours to a few days to process. Banks and other lenders use your credit score, credit history, and application to determine how risky an investment you are. Some online lenders may also use alternative data such as employment history and social media activity to help gauge your creditworthiness.
4. What can you expect during repayment?
Personal loans follow the familiar cadence of traditional loans. Once your application is approved, you’re given a few months to several years to pay back the loan amount, plus interest. With a fixed-rate loan, the payment amount stays the same for each payment period, so you’re better able to balance your payments with the rest of your budget.
Payday loans, on the other hand, can be tricky to manage if you’re not careful. Instead of repaying in monthly installments, borrowers must pay back the entire amount owed on their next payday (usually two to four weeks after applying for the loan).
If you’re unable to make this payment, lenders will allow you to take a second loan to pay off the first—along with another flat fee. This can quickly turn into a cycle of debt that is difficult to break. Even though 12 million Americans use payday loans each year, a study conducted by the Pew Charitable Trusts found that only 14% of borrowers had the means to repay them.
Another thing you’ll want to keep in mind: Paying your personal loan consistently and on time can help build up your credit score and opens up more loan and interest rate options. Payday loan lenders, however, usually don’t report on-time payments to credit bureaus, meaning timely repayments won’t impact your credit score.
In most cases, personal loans prove to be a better option. Their predictable payments make it easier for borrowers to pay back the loan without overwhelming themselves—which is especially important if you’re having trouble covering your finances in the first place. Their lower interest rates also make personal loans a more practical option for many borrowers.
However, you may find yourself in a situation where personal loans aren’t a good fit. Maybe a lack of credit history prevents you from applying, or maybe you need less than $1,000. In cases like these, a payday loan may be a feasible option. But, take care to consider the drawbacks of payday loans, as well.
They come with higher risks than traditional loans, so make sure you’re able to pay back the money immediately. The excessive interest fees are not the only thing to look out for; you can also get hit with overdraft fees if your lender withdraws from an empty account.
It is important to understand that you have a variety of options when you need money fast. Take the time to figure out what is right for you. Your decision affects the health of your long-term finances, so you’ll want to weigh your options carefully. If you need money now, consider applying for a personal loan with Personify Financial. Our online application process is simple and straightforward, and loans can be funded in as little as 24 hours.
Opening a new loan is a decision you want to make strategically. However, understanding all the variables involved will help you choose the right one with confidence.