Payday vs. Personal Loans: Which is Better?
Many people need to borrow money on occasion to take care of unexpected expenses. Maybe the automatic transmission on your car suddenly refused to change gears, for example, and you need to have it repaired. Or perhaps you received an unexpected medical bill that needs to be quickly paid.
It’s good to have options when it comes to financing, and two popular loans for obtaining some quick cash are payday loans and personal loans.
What are the differences between payday loans vs. personal loans? Is one better than the other?
The following is an overview of payday and personal loans to help you decide which option is best for your needs.
How Do Payday Loans Work?
Payday loans are offered by private lenders for relatively small amounts of money – usually $500 or less, although they can be for more in some cases. They are highly flexible, and the money can be used for many different purposes.
Payday loans are very short-term loans. The full amount of the loan is usually due the next time the borrower gets paid (hence the name). Since people are paid differently, the term for these loans is usually 2-4 weeks.
Payday loans have very high interest rates. For every $100 that you borrow through a payday lender, you can expect to pay $10-$30 in interest. Some states regulate the amount of interest that payday lenders can charge. Other states prohibit this form of lending with the argument that it is a form of predatory lending targeting those who can least afford it.
How Do You Qualify for a Payday Loan?
Payday loans are usually very easy to obtain, and many lenders don’t even do credit checks. Qualifications for payday loans typically include:
- Be at least 18 years old
- A checking account from a bank or credit union
- Proof of employment and verification of income
- Valid identification
When you apply for a payday loan, lenders usually require you to sign a post-dated check for the full amount of the loan plus interest. Some lenders will also require you to authorize an electronic payment. If you don’t repay the borrowed money when it is due, the lender will go ahead and either process the check or withdraw the funds from your bank account.
How Do Personal Loans Work?
Personal loans are obtained from banks and credit unions and can be used for many different purposes. The amount you can borrow is typically between $5,000 and $50,000, although they are sometimes for higher amounts.
With a personal loan, you will receive a lump-sum payment for the total loan amount. You then repay it over time with fixed monthly payments.
The terms for personal loans vary depending on the loan amount and the lender. The minimum is usually 12 months, but it can be as high as 10 years. These loans are also unsecured, which means that you do not need collateral to obtain one.
Interest rates for personal loans are significantly lower than the rates for payday loans. The rates are usually fixed but may be variable in some cases.
How Do You Qualify for a Personal Loan?
Personal loans are more difficult to obtain than payday loans. Information you will need to provide when applying includes:
- Requested loan amount
- Reason for the loan
- Employment information and annual income
- Other personal financial information
When applying for a personal loan, a hard credit check will be done. Hard credit checks do appear on your credit reports, and they will also temporarily reduce your credit score by a few points.
Eligibility for personal loans primarily depends on your credit score, how much debt you currently have, and your income. Required credit scores vary depending on the lender.
Payday Loan vs. Personal Loan: Which Should You Choose?
Choosing between a payday loan or a personal loan depends on how much you need to borrow and your credit history. For very small loan amounts, a short-term payday loan may meet your needs. Just keep in mind that the full amount of the principal and interest will be due the next time you get paid.
A payday loan may also be your only option if you have a low credit score. Since personal loans are not secured by collateral, credit scores are used by lenders to ensure that the money they lend will be repaid.
Overall, personal loans are better than payday loans. You can borrow more money, the interest rates are much lower, and you can take significantly longer to repay the debt. A negative to consider with these loans is that you do need a good credit score to qualify. Many lenders also have minimum loan amounts that they will consider.
If you are thinking about applying for a personal loan, the following guide provides an overview of how they work and how to apply for one.