Personal Loans vs. Payday Loans

Personal loans and payday loans can be useful when money is tight. They can help when an unexpected expense arises or you’re making a large purchase. In addition, these loans can be useful for consolidating multiple debt payments into one.

However, personal loans and payday loans are not the same. Keep reading because we’ll compare these two types of loans, discuss their differences, and examine their pros and cons. If you are considering one of these loans (or both), we’ll take a closer look to help you make the best decision in your situation.

What’s the difference between payday loans vs. personal loans?

While payday and personal loans can help you make up for a budget shortfall, the two are more different than similar. For instance, payday loans usually have a much higher APR than personal loans because they often have a much shorter repayment period—by the next payday, in many cases.

In theory, this means payday loan borrowers should be debt-free in two weeks or less. However, according to The Pew Charitable Trusts, most renew the loan or reborrow. Pew says the average payday loan is more than a third the size of the borrower’s paycheck, leading to a debt cycle.

Here’s a quick look at how these two loans compare:

Personal loan	Payday loan
⬇️ Lower fees and interest rates	⬆️ High fees and interest rates
✅ Credit check for approval	❌ No credit check for approval
⏳ Repay in up to 144 months	⌛ Repay in 2 weeks
🐢 Require an application, making them more difficult to obtain	🐇 Easy to obtain
💲💲💲Loans range from $1,000 to $100,000	💲 Loans range from $100 to $500

Payday loans are more of a last resort for paying for immediate expenses and needs. 

Personal loans are a more structured, lower-cost option for covering larger expenses or debt consolidation.

How do personal loans work? 

Personal loans allow you to borrow money for various purposes. You can get many different types of personal loans, such as online loans and bank loans. Let’s take a closer look at personal loans and how they work, including:

• Interest rates
• Repayment terms
• Application process
• Risks of borrowing

Interest rates

The interest rate on a personal loan can vary. The interest rate is almost always fixed, meaning rates stay the same for the entire term.

The average interest rate for a personal loan depends on your creditworthiness. The higher the rate, the more you will pay on the loan. In April 2024, you can expect a rate between 7% and 36%.

Repayment terms

This determines how long you make monthly payments. Typical repayment terms last from 12 to 84 months. However, longer or shorter repayment terms exist with certain lenders. Longer terms mean lower monthly payments but more interest.

Application process

To get the best offer, consider applying with several lenders. Many lenders have prequalification tools to assess your approval odds before you submit a full application. The application will ask for relevant information about you and your finances, such as your name, income, and employment information.

The application can take 15 minutes or less, making it relatively easy. If you are approved and accept the loan, you can have your money within three business days. In some cases, same-day funding is available.

Risks of borrowing

Like all forms of debt, risk is involved for the lender and the borrower. As the borrower, you assume the risk because missing payments or paying late can damage your credit. If the loan is secured, you risk losing assets, such as your house or car. If you default on the loan, you can cause severe damage to your credit, which may take years to recover from.

How do payday loans work? 

Payday loans are often marketed as short-term solutions for urgent cash needs. However, be aware of their sky-high costs and significant risks. Here are the details on payday loans:

• Interest rates
• Repayment terms
• Application process
• Risks of borrowing

Interest rates

Because payday loans have a short repayment term, they don’t charge interest like personal loans. Instead, they charge a fee that may range from $10 to $30. According to the Consumer Financial Protection Bureau, a $15 fee on a $100 payday loan is equal to an APR of almost 400%.

Because payday loan borrowers often renew their loans, the impact of these fees is much higher than it may seem at first. As Pew Research notes, most personal loan borrowers pay more in fees than the amount they first borrowed.

Repayment terms

Payday loans are often due by your next pay period, within two weeks. While you should be debt-free soon, it leaves you little time to scrape together enough money for the lump-sum payment. It’s often rolled over into a new loan if you can’t repay it in time.

Application process

Applying for a payday loan is simple, especially compared to personal loans. The only requirements are often to be 18 years of age and provide proof of income and identity. You can obtain them from a storefront lender or online, making them easy to access even if you have poor credit.

Risks of borrowing

The risk of borrowing is often higher for payday loans compared to an unsecured personal loan. Payday loans tend to have super high fees and short repayment periods, making them difficult to pay on time. This often creates a debt trap that’s difficult to escape from.

Defaulting on a payday loan can also result in a collection action, which can damage your credit score. Before taking on one of these loans, be sure you understand the risks.

Pros and cons of payday loans vs. personal loans

Now, let’s look at the pros and cons of both products.

Personal loan pros and cons

First, consider the risks and drawbacks of a personal loan.

Pros

• Much lower interest rates than payday loans and even credit cards, in many cases

• Fixed interest rates and predictable payments make budgeting easier

• You can use the money for almost any purpose

• Larger loan amounts than payday loans

Cons

• Require a credit check, making it tougher to qualify if you have poor or no credit

• Application process is more involved than payday loans

Payday loan pros and cons

Here’s what to consider before taking out a payday loan.

Pros

• Fast access to cash, making it a quick way to get money in an emergency

• You can use the money for almost any purpose

Cons

• Sky-high fees, often with three-digit APRs

• Most borrowers roll payday loans into new loans because they can’t afford to repay them

• Most payday lenders don’t report to credit bureaus, so they don’t build credit

• Payday lenders often use aggressive collection practices

• Can cause significant financial damage if you’re unable to pay

Are payday loans or personal loans better? 

Personal loans are almost always a better choice than payday loans. The latter might have a few small advantages, but the benefits rarely outweigh the risks. Payday loans are often difficult to repay, and most borrowers renew their loans.

In addition, payday loans lack the benefits of personal loans, such as positive credit score impacts. Paying a personal loan on time can boost your credit score, but that’s unlikely with a payday loan, even if you pay on time. However, payday lenders won’t hesitate to collect if you fail to pay.

You might consider payday loans if both of these apply, but only with extreme caution:

• Last resort: You’ve tried everything else, such as borrowing money from friends or family or getting a cash advance with a credit card or cash advance app. If you need the money now and are out of options, you might consider a payday loan.
• You can repay it: If you’re certain you can pay the loan on time, it could be worth considering. Compare your upcoming expenses to your next paycheck so you know this is the case. But remember that more unexpected expenses can arise, so you should have extra money just in case.

Payday loans are rarely worth the high risk and cost, but they could be worth considering if you’ve run out of options and can repay the loan.

How to apply for a personal loan 

Because payday loans are rarely worth the risk, we recommend applying for a personal loan if you need cash. Here’s how it works:

1. Prepare: First, check your credit and determine how much money you need. Gather documents, including pay stubs and your driver’s license.
2. Compare lenders: Shop around for different lenders, including online lenders, banks, and credit unions. Many lenders allow you to prequalify to check your approval odds without affecting your credit score.
3. Apply: Choose a lender with the best offer for your needs, and complete an online or in-person application.
4. Review and accept: The lender will review the application and your creditworthiness, which could take a few minutes to a few business days. If you’re approved, you’ll receive a loan agreement that includes the interest rate, terms, and fees. If you agree, sign the agreement.
5. Funding: If you accept and sign the loan agreement, you’ll get the money in your bank account within a few business days.

Although personal loans are generally safer than payday loans, you should still read the fine print and compare lenders to get the best offer. In addition, make sure you can comfortably make at least the minimum payment before accepting the loan.

FAQ

Can you get a personal loan with bad credit?

Yes, securing a personal loan with bad credit is possible. However, you may face more restrictions. For example, lenders tend to offer higher interest rates. Some require a cosigner, someone with a stronger credit history who agrees to take on the loan if the borrower defaults. Remember, a personal loan should be part of a larger plan to improve your financial situation.

Is a personal loan secured or unsecured debt?

A personal loan can be secured or unsecured. A secured loan requires collateral, such as a car or a house, which the lender can claim if you default on the loan. An unsecured personal loan does not require collateral. However, lenders may charge higher interest rates on unsecured loans due to the increased risk.

Why are payday loans difficult to pay back?

Many borrowers find it challenging to repay their payday loans due to the short repayment time frame and high interest rates. Most payday loans have a repayment period of two weeks and come with triple-digit APRs. If you borrow a payday loan and struggle to repay it by the due date, you might find yourself trapped in a cycle of debt. It’s crucial to consider all your loan options and understand the terms before borrowing.