Payday loans and personal loans have some similarities. They are both unsecured loans with no collateral. Both typically offer fast approval and release of funds. Neither loan is tied to a specific purpose: you can use the money any way you want.
They are still very different types of loans, and the differences can be extremely important.
Let’s compare these two types of financing.
What are Payday Loans?
Payday loans are among the most popular loans in America. There are 23,000 storefront payday lenders in the country, more than twice the number of McDonald’s restaurants, and many more lend online.
These are some of the characteristics of payday loans:
- Easy qualification. There’s no credit check or minimum credit score. Anyone with an income and a bank account can borrow.
- Small amounts. Some payday lenders lend up to $1000, but most loans are from $300 to $500.
- Single payments. A payday loan is meant to be paid in a lump sum on your next payday.
- Automatic payments. A payday lender will request a post-dated check or authorization to withdraw directly from your bank account. They won’t wait for you to pay.
- Very high rates. Payday loan fees may reach 400% to 600% on an annual basis.
- Rollovers. Most payday lenders will roll over your loan for an additional fee if you can’t pay on the due date.
- Limited availability. Some states ban or restrict payday loans.
Payday loans are a fast, easy way to get money to carry you through until your next payday. They are also a fast, easy way to get trapped into a cycle of debt at astronomical interest rates.
Most borrowers can’t pay off their loans: the CFPB estimates that 80% of payday loans are rolled over, and over 60% are part of “loan sequences” of seven or more loans in a row. These borrowers often end up paying back more than they borrowed in the first place.
Tip: A payday loan may also be called a payday advance, check loan, small-dollar loan, payroll loan, salary loan, or cash advance loan.
What are Personal Loans?
Personal loans are typically made by banks, credit unions, and online lenders. These are some key features of personal loans.
- Higher lending standards. Personal loan lenders will check your credit. If you have poor credit or no credit score, it’s hard to get approved.
- Larger amounts. Many personal loan lenders will lend up to $50,000 to qualified borrowers. Some will lend more.
- Multiple payments. Personal loans are paid off in monthly installments, usually over terms of three to five years.
- You have to make payments. You can authorize an automatic payment from your checking account, but the lender won’t make a withdrawal.
- Low interest rates. The average personal loan rate is about 10% per year. Your rate will depend on your credit score and other factors, but personal loan rates almost never exceed 30% per year.
- Wide availability. Personal loans are available in all states.
Personal loans, also called consumer loans, are designed to pay for large purchases or expenses. The most common uses of personal loans are debt consolidation, medical costs, vacations, marriage ceremonies, birthdays and other celebrations, vehicle repairs, and home renovations.
Payday Loans vs. Personal Loans: What’s the Difference
Payday Loans and personal loans are different financial products made for different purposes.
- Payday loans are small, short-term loans designed to get you through to your next paycheck. They are usually used by people with poor credit and little access to other loans. 70%of borrowers use their loans to pay for routine recurring expenses.
- Personal loans are larger installment loans typically used by borrowers with at least fair credit. They are usually used for planned major expenses, not to cover an emergency shortfall.
Payday loans are used by people under serious financial stress. The average payday loan borrower earns around $30,000 per year, and 58% of borrowers have trouble meeting routine expenses.
Personal loans are typically used by borrowers trying to get ahead. Payday loans are used by borrowers trying to catch up.
What if You Can’t Pay?
A significant similarity between payday and personal loans is that they are usually unsecured, so there is no ownership or asset behind the loan. In other words, in the event of non-payment of a payday loan or a personal loan, the lender cannot seize anything.
But what happens if you can?t pay your loan?
If you fail to make payments on a personal loan, the lender will report the late payments to the credit bureaus, and your score will drop.
If your account becomes seriously delinquent, it may be charged off and sent to a collection agency. The collector will pursue you, your credit will drop more, and the collection agency could sue you.
If you can’t afford to pay a payday loan, you can roll it over into another loan. This is very common. It’s what the lender wants you to do: they make more money when you roll the loan over. It’s also a huge drain on your finances.
When your payday loan becomes due, the lender will deposit your post-dated check or make a direct withdrawal from your checking account. If your account doesn’t cover it, you may be hit with an overdraft or insufficient funds fee.
These fees can add up fast. Your lender may make repeated attempts to draw their payment, and each one will trigger a fee.
Payday lenders do not report to the credit bureaus, so missed payments will not affect your credit score. If the lender sends the account to a collection agency, it will be reported, and it will affect your credit.
The lender or collection could file a collection lawsuit against you. If the judge rules against you, your wages could be garnished.
Personal Loans vs. Payday Loans: Pros & Cons
Here is a rundown of the pros and cons.
Pros of Payday Loans
- No Credit Check. You can get a payday loan even with bad credit or no credit score.
- Quick Acceptance. Many payday lenders will give you a loan offer in minutes.
- Fast Cash. The loan money can get to your bank account in an hour or less.
- It Is An Unsecured Loan payday lenders offer unsecured borrowing, which means you are not directly putting your personal property at risk.
Cons of Payday Loans
- They are Costly. Payday loans carry extraordinarily high interest rates. It’s easy to see how some people have difficulty paying back payday lenders when the costs are so high.
- Payday Loans Are Considered Predatory. Some people see payday loans as abusive because they target low-income people with poor credit. Watch out for payday loan scams.
- Payday Lenders Want Access to Your Bank Account. The lender may make repeated attempts to withdraw the funds, which often involves multiple overdraft charges of $35 or more. Some have been known to make unauthorized withdrawals.
Pros of Personal Loans
- There is no collateral. Most personal loans are unsecured. You don’t need to risk vital assets.
- They are flexible. Personal loans can be used for many things, from debt consolidation to medical expenses. A personal loan can be a good alternative if you want to finance a major purchase or expenditure.
- They can build credit. If you consistently make payments on time, it can help you increase your credit score.
- Interest rates are reasonable. If you have reasonably good credit, you can get a personal loan at a competitive interest rate.
Cons of Personal Loans
- They may come with fees. Some lenders charge application fees, origination fees, late fees, and others. Check the fee structure carefully before signing a loan agreement.
- They can encourage unnecessary spending. The easy availability of personal loans can lead you to take on a more expensive wedding, vacation, or purchase than you otherwise would.
- They Have Stricter Qualification Requirements. Personal loan lenders require a credit check and will also consider your income, debt-to-income ratio, and other factors.
Which Should You Use?
In most cases, it won’t be a choice. If you qualify for a personal loan, you’re probably not in the market for a payday loan.
If you do have a choice, it should be clear: a personal loan is a far cheaper and generally better option. Payday loans are designed to trap you in a cycle of high-interest debt that will cost you far more than you initially borrowed.
If you think you don’t have a choice, remember that there are alternatives to payday loans. Examine all your options before you make a decision!