Payday Loans vs. Personal Loans: What You Need to Know
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- Payday loans usually come with very high interest rates, and are often based on your income.
- Personal loans are long-term installment loans that usually have lower rates than payday loans.
- Payday loans are always a worse option than personal loans because of their high rates.
Introduction
Taking out a loan can be a helpful way to afford costs you may not otherwise be able to cover at the moment. You may want to borrow to cover medical expenses, home improvements, or possibly even a vacation.
The most common forms of loans for quick cash are payday loans and personal loans, though one is a far better option than the other.
Overview of payday and personal loans
A payday loan is a high-cost, short-term unsecured loan that has a principal that is a portion of your next paycheck. A personal loan is a long-term unsecured loan with higher minimum loan amounts and lower interest rates. You can use the money from either pretty much however you want to; aside from that, they have few similarities.
Stefanie O'Connell Rodriguez, the host of Real Simple's Money Confidential podcast and a personal finance expert with Discover, recommends steering clear of payday loans if at all possible.
"It's an option of last resort, like truly avoid it at all costs," O'Connell Rodriguez says. "If you're weighing something like, 'OK, do I use a payday loan or a credit card or a personal loan,' understanding that the payday loan is the option of last resort might help make that decision a little bit easier."
What is a payday loan?
Definition and key features
Payday loans are often for small amounts of money, commonly $500 or less. They are designed for borrowers who are in a pinch — maybe you need cash to cover an unexpected medical bill or a damaged item. Payday loans provide immediate funds, come with extremely high interest rates, and are usually based on your income, not your credit history.
Interest rates and fees
"Payday loans come at a price," says Kendall Clayborne, a certified financial planner at SoFi. "They may have interest rates of more than 600%. Such high-interest rates, not to mention other associated fees, can quickly lead to situations where you end up getting behind on the loan and have to borrow more and more in order to pay it back."
Payday loans are never a better option than personal loans. They come with extremely high interest rates and are often predatory in nature.
Repayment terms
You can get a payday loan by walking into a brick and mortar lender or via an online lender. When you take out a payday loan, you'll often agree to give the lender permission to withdraw funds from your bank after your check has been deposited. The lender might ask for a signed check so they get the funds shortly after your next paycheck.
What is a personal loan?
Definition and key features
With a personal loan, you apply to take out a specific amount of money. The lender will show you available offers depending on financial factors such as your credit score, debt-to-income ratio, and ability to repay the loan. You can use a personal loan for a variety of reasons, including home improvement, medical bills, and vacation.
"Personal loans come with a credit check to qualify, but will give you a longer term to pay them back," Clayborne says. "Your repayment timeline may be less stressful — giving you flexibility to pay over the course of a few years rather than a few months. With a longer payment term, your personal loan may be more manageable than a payday loan."
Interest rates and fees
Personal loans are always a better option than payday loans, as they come with lower interest rates and the lending decision is based on your ability to repay. Most personal loans have fixed interest rates that stay the same over the life of the loan.
Repayment terms
Online lenders, banks, and credit unions will give you money that you repay over a fixed period, say one year or five years. Personal loans are almost always unsecured, which means they don't require collateral — like a house or a car in the case of a mortgage or auto loan — to receive.
Comparing payday and personal loans
| Payday loans | Personal loans | |
| Interest rates | Very high | Range depending on your credit history |
| Loan durations | By pay period | Range from a few months to several years |
| Application process | Swift, usually no credit check | Longer, almost always a credit check |
| Loan amounts | Often lower loan minimums | Often higher loan maximums |
See our picks for the best personal loans »
Advantages and disadvantages
Pros and cons of payday loans
| Pros | Cons |
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Pros and cons of personal loans
| Pros | Cons |
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Other financing alternatives
- Borrow from friends and family. While it may be uncomfortable asking your loved ones for money, you might get better terms when you borrow from people close to you. The repayment term length may be more lax and you might not even be charged interest.
- Apply for a credit card. Credit cards offer revolving lines of credit, which means you can borrow up to a limit, and when you pay it back, you can borrow up to that amount again. It could be a better choice if you don't need a lump sum. Some credit cards may even offer a zero-interest introductory rate.
- Work more hours or take on another job. This could require a significant lifestyle change. It could increase your childcare costs, drive up your emotional stress levels, and leave less time to enjoy life. That said, increasing your cash flow reduces the need to borrow, making it an attractive, although difficult, option if you prefer to avoid debt.
FAQs
Can payday loans affect my credit score?
Payday loans can affect your credit score if the loan goes to collections and is reported to credit bureaus. However, lenders typically do not report on-time repayments to the credit bureaus.
Are personal loans better for large expenses?
Personal loans are better for larger expenses. They offer larger loan amounts, longer repayment terms, and lower interest rates compared to payday loans, making them more suitable for significant financial needs.
How fast can I get a payday loan compared to a personal loan?
Payday loans are often available almost immediately, sometimes within 24 hours of application. Personal loans may take longer to process, typically a few days to a week.
What's required to qualify for a personal loan compared to a payday loan?
Personal loans usually require a credit check and factor in your credit score, income, and debt-to-income ratio for approval. Payday loans have fewer requirements, usually proof of income and a bank account, but come with higher interest rates and fees.
Can I pay off a payday loan with a personal loan?
You can use a personal loan to pay off a payday loan. This can consolidate high-interest payday loan debt into a single, lower-interest personal loan, potentially saving money on interest.