Payday loans and personal loans are very different financial products.
When you need to borrow money, you have several options for taking out a loan.
Personal loans can be an affordable option, and it’s often a good idea to take on this type of debt. Payday loans, on the other hand, are almost always very expensive and should be avoided whenever possible.
The two main differences between personal loans and payday loans are borrowing costs and repayment time.
Here’s why these differences matter.
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1. Borrowing costs
Payday loans are significantly more expensive than personal loans in virtually all circumstances.
When you take out a payday loan, you typically pay an upfront fee that can range from $10 to $30 for every $100 you borrow. So if you borrow $100, you may owe $110 or $130 immediately after taking out the loan. That might not seem like a lot, but as the Consumer Financial Protection Bureau explains, it actually equates to an annual percentage rate (APR) of 400% or more.
Personal loans, on the other hand, often don’t come with an upfront fee. And if you’re charged an application or origination fee, it’s usually a very small percentage of your loan value. Instead of paying an upfront fee, you’ll pay interest as you borrow.
Personal loan rates can vary widely but are generally between 10% and 28% depending on your financial credentials. In some cases, it is possible to get a much better rate than that.
But, in general, the fees and effective interest rate you’ll be charged on a personal loan will be much lower than what a payday lender will charge you.
2. Payment time
The repayment term is another huge difference between personal loans and payday loans.
When you take out a personal loan, it is common to have over a year to make your repayments. In some cases, you could have up to a decade or more depending on the amount borrowed and the lender you work with. Because you’re repaying your borrowed money over a long period of time, each monthly payment should ideally be affordable, and you should be able to fit the payments into your budget.
A payday loan, on the other hand, is expressly designed to be a short-term loan. You will usually only have about two weeks to repay the full amount borrowed, including any fees you owe. And that’s a huge problem because it means you’ll have to come up with a large lump sum in a very short time.
Most people who take out payday loans do so because they need immediate cash. Unfortunately, if you find yourself in a difficult financial situation requiring a payday loan, it is unlikely that your finances will have improved significantly in the two weeks you have to prepare for repayment.
The result is that many people can not repay the full amount of their payday loan once they receive their paycheque. This leads to more borrowing and more fees, which can lead to spiraling debt. This is where your future paycheck – instead of going to your bank account – is always promised to a payday lender, who then invites you to take out another payday loan to cover your expenses since your check is gone. before you earn it.
Since payday loans have serious drawbacks in terms of repayment time and cost compared to personal loans, always aim for a personal loan rather than a payday loan if you can. And be sure to read the fine print of any lender you work with and confirm that you know both the costs you will pay for your loan as well as the time you have to become debt free.
The Ascent’s Best Personal Loans for 2021
The Ascent team has scoured the market to bring you a shortlist of the best personal loan providers. Whether you’re looking to pay off debt faster by lowering your interest rate or need extra money to make a big purchase, these top picks can help you reach your financial goals. Click here for the full rundown of The Ascent’s top picks.