Payday Loans vs. Personal Loans: What You Need To Know
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Summary:
If you need to borrow money, you have several choices available to you. Two loan options are payday loans and personal loans. Payday loans are simple to apply for and pretty easy to get, but they charge high interest rates and have very short loan terms. The application process for personal loans is more complicated than for payday loans and approval is more difficult to achieve. However, the interest rates are typically lower and you’ll have a lot more time to pay it back. All in all, while personal loans are tougher to get, they are by far the safer loan option.
Emergencies happen. Your car finally quits for good, the hot water heater blows up, or your child has an accident that results in steep medical bills. So where do you turn if your emergency fund isn’t enough or, worse, doesn’t even exist?
You hear about payday loans all the time and it seems like this might be the quick fix you’re looking for. A little something to tide you over until you get your next paycheck. Not so fast, though. Maybe a personal loan is the better choice. Let’s compare and contrast the two options and see if one or the other is better for your financial situation.
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Payday loans vs. personal loans
Sometimes, in an emergency, a payday loan could be your only choice to quickly get your hands on some cash. But, if you can qualify and don’t need the money right now, you might want to look into getting a personal loan instead.
How payday loans work
As mentioned, payday loans are pretty easy to get, although they’re not quite as easy as some payday lenders will lead you to believe. Many claim to have “no credit check” or “no denial” payday loans, but in actuality, all lenders have some kind of requirements.
By no credit check, they might simply mean no hard inquiry (which will impact your credit score), for example. However, they might still do a soft credit check that gives lenders an idea of whether or not you normally pay your debts.
Having said that, payday loans tend to be fairly simple to gain approval for. Most of the time you can apply online in minutes and get approved right away, with the money arriving in your bank account in a matter of hours or the next day. Basically, if you don’t have the worst credit in the world and meet the following qualifications, you can expect to be approved for a payday loan. To qualify, you must:
- Be a U.S. citizen over the age of 18
- Have a steady job showing reasonable income
- Have a bank account
Dangers of payday loans
What you need to be careful about is paying that loan back in full, on time, and with interest. If you find that’s not possible, you risk falling into a dangerous payday loan cycle. This can happen when, if you can’t pay the loan back, the lender may offer to roll the original loan over into a new payday loan with its own set of interest rates and fees.
You might imagine how this can snowball quickly. In fact, the Consumer Financial Protection Bureau (CFPB) reported that 80% of all payday loans are rolled over or renewed. The same study showed that most payday loan borrowers renew their loans so much that they often owe more in fees than they originally borrowed.
The bottom line with payday loans is they might be okay for an emergency but only if you can repay it on time and not rely on such loans. This is also a good time to come up with a better plan for future incidents where you might need to get your hands on some emergency money.
How personal loans work
Personal loans are definitely harder to get than payday loans, which can be problematic if you have less than ideal credit. You will need to have a good credit history, sufficient income, and a low debt-to-income ratio (DTI). Personal loan lenders prefer to see no more than a 43% DTI. The higher your credit score and the lower your DTI, the better interest rates and loan terms you can be approved for. Here is a rough idea of what interest rates you can expect when compared to other popular loan types.
Personal loans also take a little longer for approval and disbursement than payday loans because of more stringent credit requirements. This is because a bank, credit union, online lender, or other financial institution will be more concerned with your ability to repay the loan than those who offer payday loans. However, you could still have the money deposited into your bank account within a week or two in a best-case scenario.
Another plus for personal loans is the ability to borrow significantly more money than a payday loan allows for (hundreds versus thousands) and a lot more time to pay it back. You will also have fixed interest rates, which translate into fixed monthly payments, making it easier to budget for your loan payments.
Unsecured vs. secured loans
Unsecured personal loans are very common, but there’s no law that says they have to be. Maybe you have a pretty nice car that’s worth some decent cash and it’s already paid off. The point is, if you do have some collateral to put up, you should be able to garner a more favorable interest rate than with unsecured personal loans.
Alternatives to payday loans
Before you hop online to apply for a payday loan to get you over a hump, first exhaust all of your other options. Maybe a friend or family member could spot you a loan or you could pick up some extra hours at your job. Read on for other ideas to pay your emergency expenses.
Savings
You may be reluctant to dip into your savings when you need some extra cash, but if you have it and you need it, it’s probably the wisest course of action in an emergency situation. It’s a lot easier to save more money than it is to pay back a payday loan or a personal loan that will charge you interest on top of the loan amount.
If you don’t have a place to put aside your savings, consider one of the savings accounts below.
Credit cards
Despite relatively high interest rates, a credit card is still a better option than a payday loan. It might hurt to plunk down your card for a relatively large expense, but you can resolve to pay it back as soon as possible so as to minimize the interest payments.
Even better, if your credit score is good, you might want to apply for a new credit card with a 0% introductory interest rate. Many of these cards let you make purchases interest-free for up to two years. That’s a great deal if you can get it — think of it as a no-interest loan with a year or more to pay it back.
In an extreme emergency, where you need cash this minute, you could also get a cash advance on your credit card. You can do this from any ATM or at banks or credit unions. Keep in mind that interest rates for cash advances are much higher than for regular purchases — typically around 24% — which makes for a particularly costly loan. However, if you don’t think you’ll need a cash advance any time soon, take a look at some of the credit card options below.
Payment plans
Depending on the reason why you need to get ahold of some cash pretty quickly, you might see if a payment plan is available for your situation.
For example, if you have a medical emergency and wrack up some hefty hospital bills, a loan may not even be necessary. Many clinics and hospitals will offer payment plans and oftentimes they won’t even charge interest. Even if they do, it will likely be far less than any payday loan or personal loan would charge.
Related reading: Looking for other ways to get ahold of some quick cash in an emergency? Check out SuperMoney’s guide to payday loan alternatives if you need money fast.
How to beef up your credit scores
If you believe you may need fast money in the near future, you may want to take a closer look at your finances and see where you could make some changes. If you have a lot of debt, for example, you might want to consider getting a side job to help pay down that debt, which will increase your credit score.
Another great idea, which you should plan to make a regular chore, is to get a copy of your free credit report. Using AnnualCreditReport.com, you can get a free report from the three major credit bureaus — Experian, Equifax, and TransUnion.
It’s important to regularly go through your reports, keeping an eye out for accounts you don’t recognize or other any other mistakes. If you do find any erroneous information, you can dispute it in writing and have it removed from your credit report. This is one of the quickest ways to boost your credit score, therefore increasing your chances of loan approval.
Pro Tip
Debt consolidation is an excellent use for a personal loan. You can get rid of high-interest credit card debt, for example, and demonstrate your ability to make timely payments. All of this will help to improve your credit history and head you down the path to healthy finances.
FAQs
What is the major downside of a payday loan?
While a payday loan can occasionally be handy in an emergency, it has two major drawbacks: high interest rates and shorter loan periods. This combination can make it difficult for borrowers to pay back the full amount, which can lead to an insidious cycle of debt.
Does a personal loan affect your credit score?
Getting a personal loan will affect your credit score but largely in a positive way if you manage it properly. As part of the application process, lenders will do a hard credit check, which can drop you a few points temporarily.
However, making timely monthly payments after loan approval can do nothing but good for your credit score. Keep in mind, though, that even one late payment can negatively impact your credit score.
What are normal payday loan interest rates?
A lot of payday loan lenders may not even really disclose their actual interest rate. For example, they might say they only charge $15 per $100 borrowed. That doesn’t sound too terrible, right? It actually sounds a lot like they are only charging a 15% interest rate.
Some may view this pricing method as deceptive and predatory. A two-week loan of $300 will ultimately cost you $345, which amounts to almost a 400% annual percentage rate (APR).
Key Takeaways
- Payday loans are pretty easy to get, but they come with very high interest rates and short repayment periods.
- Personal loans are more difficult to get, but the interest rates and loan terms are far more favorable than payday loans.
- Think about alternative ways to come up with some quick cash before resorting to a payday loan.
- If you’re choosing between personal loans vs. payday loans, you’re better off going with a personal loan if you can qualify. They’re a much safer alternative to payday loans.
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