Personal Loans vs. Payday Loans

Payday loans are a quick-fix solution for immediate cash needs. They have a fairly straightforward application process, and no credit check is required.

So why are payday loans so much easier to qualify for than traditional bank loans?

First, they have less strict lending requirements. For instance, you typically only need a bank account, a form of identification, and proof of income, like a pay stub.

With payday loans, you can walk into a payday loan center and have cash in hand or have the funds dropped into your account within the next business day. Payday loan amounts are generally small, usually $500 or less.¹

While fast and convenient, payday loans have very high fees – $10 to $30 for every $100 borrowed. The full amount is due on your next payday. So if you owe $15 for every $100 loaned, that’s the equivalent of an APR of 400%.²

Because of these high fees, which can be viewed as predatory, payday loans are banned in several states, including Arizona, Arkansas, Connecticut, Georgia, Illinois, Maryland, Massachusetts, Montana, Nebraska, New Hampshire, New Jersey, New Mexico, New York, North Carolina, Pennsylvania, South Dakota, Vermont, and West Virginia, and Washington, D.C. Plus, they’re restricted in a handful of other states.³

If you decide a payday loan is necessary, you can apply for one online or at a retail location. Here are the steps you can take to prepare to submit your loan application.

1. Determine your loan amount

Figure out how exactly much money you need to bridge the gap until your next paycheck. Since payday loans are expensive, you don’t want to borrow more than you need.

2. Review your credit score

Even though most payday lenders don’t check your credit, it’s still a good idea to know where you stand. If you’ve been working on your score, you can check to see if it’s high enough to apply for a different type of loan with a lower interest rate and fees.

3. Compare loan offers

The cost to borrow a payday loan can vary based on where you live and between lenders. Compare a few different options to see where you can find the best offer.

4. Submit your loan application

Once you pick a lender, submit your loan application. Depending on the lender you can submit your application online or in person. Most payday lenders require that you have:

• An active bank account
• Proof of income (pay stub)
• Valid identification

5. Finalize and receive your loan

Many online payday lenders will review your loan and give you a decision within minutes. If you’re approved, you can receive your money in your bank account in as little as 24 hours.

Before you receive a payday loan, you’ll provide authorization to access funds from your bank or provide a post-dated check for the entire balance.² This way, if you don’t pay your payday loan on the due date, the lender can cash your check or withdraw money from your account.

If you don’t have enough money in your account to cover the loan repayment, you might incur banking fees for insufficient funds.

The payday lender may also send your debt to collections which can result in collection calls, possible legal action, and can cause your credit score to drop.⁴

If you’re stuck in a payday loan cycle of debt and want to get out, here’s what you can do.

First, avoid taking on another payday loan. Next, see if your state requires payday lenders to offer an extended payment plan (EPP).⁵ This plan allows you to repay your loan in installments over an extended period of time, with no additional fees.

If you have multiple payday loans, consider a debt consolidation loan, which can simplify the repayment process.

If you need help getting out of a payday loan cycle of debt, you can speak to a credit counselor. You can look at the Financial Counseling Association of America, or the National Foundation for Credit Counseling to find a counselor.

While payday loans are considered a form of predatory lending and are banned in some states, if it is an option for you, it’s important to get your head around their advantages and disadvantages.

Pros of payday loans

Let’s start with the benefits:

• No credit check. These loans are more accessible if you have limited or no credit history.
• Simple application. You can usually get a payday loan with proof of income, such as a paystub, a form of identification, and a bank account.
• Quick funding. You can usually receive the money the same day or within the next business day.
• Flexible use. You can essentially use the funds for any immediate need.

Cons of payday loans

Now, we’ll go over the drawbacks:

• Small loan amounts. Lending amounts for payday loans are usually for $500 or less.¹
• Short repayment terms. You’re expected to repay the loan in full by your next payday, which can cause financial strain.
• Costly. As mentioned, APRs can be 400% and up.² If you can’t pay your loan by your next payday, many customers choose to “roll over” their loan, which requires an additional fee. Plus, you still need to continue paying off your existing loan.
• Potential debt cycle. If you find yourself continuing to take out another payday loan or rolling over your existing ones, this could mean very high interest rates and fees. As your balance continues to grow, you might find yourself in a cycle of debt.

Personal loans offer larger amounts with longer repayment terms than payday loans. You can get a personal loan through a bank or online lending platform. The repayment term is anywhere from one to seven years, and depending on the lender, you can borrow amounts from $1,000 to $100,000.⁶

Interest rates for personal loans also tend to be far lower than that of payday loans. Generally, interest rates for personal loans can hover between 7% to 36%.⁶

They also tend to be unsecured, which means you don’t need to provide collateral. Some personal loans are secured, meaning the bank can seize the asset you put up for collateral if you’re unable to keep up with your loan payments.

The personal loan requirements and application process are more involved than those for payday loans. The lender will do a hard inquiry of your credit, and approval depends on your credit score, debt-to-income (DTI) ratio, and income.

If you decide a personal loan is right for you, here are the steps you can take to apply for a personal loan.

1. Check your credit score

Review your credit report and know your credit score before you start looking for a lender. This way, you’ll have a better understanding of which loans you’re likely to qualify for.

2. Explore your loan options

When looking for a personal loan, you want to compare different lenders’ fees, annual percentage rates (APRs), borrowing limits, and repayment terms.

3. Prequalify and compare rates

Once you’ve narrowed your options, see if you can prequalify with a few lenders. Then compare them to see which offers the best rates.

4. Choose a lender

After reviewing rates, fees, and other terms, choose the lender that best fits your needs and budget.

5. Complete the loan application

Depending on the lender, you can complete a loan application online or in person. Most applications only take a few minutes to complete.

6. Submit supporting documents

Most lenders will request picture identification, your social security number, proof of address, and income verification. This information helps the lender verify your identity and if you’re able to repay your loan.

7. Credit check and approval decision

While some lenders might approve your loan on the same day, others can take up to a week to make a decision. This gives them time to verify your information and perform a hard credit check.

While personal loans do have advantages, it’s important to note the potential downsides. Let’s look at both their pros and cons.

Pros of personal loans

Here are some of the advantages of personal loans:

• Fixed monthly payments. Because personal loans have predictable repayment schedules with fixed payments, it can simplify your budgeting.
• No need for collateral. Most personal loans are unsecured, requiring no collateral. However, the lending criteria might be more strict, and the interest rates might be higher than with a secured loan.
• Versatile use. The funds from a personal loan can be used for a variety of financial goals, from debt consolidation to home improvements to covering a cash shortfall.
• Higher loan amounts. Depending on the lender and what you qualify for, you can borrow up to $100,000.⁶

Cons of personal loans

Now, let’s look at some of the disadvantages:

• High interest rates. Interest rates for these loans can be high if you have poor or fair credit.
• You might borrow more than you need. If you do, you’ll be on the hook for monthly payments and interest fees longer than you would like. It’s crucial to only borrow what you need and can afford to pay back.
• Fees and penalties. Some loans come with additional costs. For instance, an origination fee for a personal loan can be anywhere from 1% to 10% of the loan amount.⁷ Let’s say you borrow $2,000. The origination fee is 3% of the loan amount, which is $60.
• They could hurt your credit score. Fall behind on your payments, and it could lower your credit.

Payday loans and personal loans aren’t your only choices. Let’s look at a few financing alternatives:

Payday alternative loans (PALs). Offered by credit unions with lower fees and longer repayment periods, PALs can provide up to $1,000 with a loan term of anywhere from one to six months.⁸

Credit cards. While an easy way to get quick access to cash, credit cards accrue interest if you don’t pay off your balance. Ideally, you’ll want to lean into credit cards for short-term financing and if you can pay off the balance quickly.

Secured loans. You do have to offer collateral, but secured loans tend to have lower interest rates and less stringent lending criteria. If you are comfortable offering an asset to back up your loan, this might be a good option for you.

Cash advance apps. These apps offer small advances from your next payday. Instead of charging interest, they might charge fast-funding fees or subscription fees. They might also ask you to provide a tip or pay it forward.

Friends and family. Family loans potentially are an interest-free option. However, you’ll need to handle them with sensitivity and thoughtfulness. You could draft a contract and lay out expectations on both ends.

While personal and payday loans are versatile, they have some major differences. Let’s take a look:

Payday loans offer a quick – but very expensive – solution for short-term financial needs. Unfortunately, payday loans often don’t consider your ability to repay. Other bad qualities of payday loans include high fees, and payments typically aren’t reported to credit bureaus. Even if you stay on top of your payments, you’re looking at APRs of 400% and upwards.

Personal loans present a more affordable option for borrowing larger amounts and factor in your ability to pay the loan back. Your payments are usually reported to credit bureaus and appear on your credit report which can potentially help build your credit.

Before deciding on any loan, consider your unique financial situation and all available options.

Don’t have stellar credit but want to get a personal loan? Learn how to get a personal loan with no credit.