Disclaimer: Upstart is not a financial advisor, the following content is for informational purposes only.
What’s the best way to get a hold of some quick cash? If you’re thinking about getting a loan, we’re going to let you in on a little secret: not all loans are created equal.
You may have heard about payday loans and what comes along with them—quick turnaround time to get cash, usually no credit check, and sheer convenience. However, they may seem like a perfect option, they do come at a cost. Payday loans typically have very high interest rates and additional fees, which may cost you more than you bargained for. A personal loan, on the other hand, could be a more solid option since you’ll know exactly what you owe over the loan term.
How do payday loans and personal loans compare? Here’s everything you need to know.
What’re the similarities between payday loans and personal loans?
Payday loans and personal loans are similar in that they can be used to pay for almost anything (think: debt consolidation, emergencies, medical bills). As a bonus, if you’re approved, you’ll get a lump-sum of money within a few business days from a lender, sometimes as quickly as one day.
That’s about where the similarities between these loan options end and the differences begin.
What is a payday loan?
A payday loan is a small unsecured loan that borrowers must pay back over a short repayment term plus a ton of interest and some fees.
If you don’t pay back the loan on time since due to the tight deadline, the lender can tack on even more interest and fees on top of what you already owe.
You should only take out a payday loan as a last resort when you’re desperate for cash ASAP.
What is a personal loan?
In most cases, a personal loan (aka a lump-sum loan) is an unsecured loan with a fixed annual percentage rate (APR) that borrowers pay back monthly over a loan term, typically 2 – 5 years.
Sometimes, when lenders want to add an extra layer of security to a loan agreement, they may offer a secured personal loan, which means it needs to be backed up by collateral. Collateral is a valuable asset that a borrower agrees to put down to support the loan. If the borrower defaults on their payments, then the lender can seize the collateral to compensate for their loss.
|A Comparison: Payday Loans vs. Personal Loans|
|Payday loan||Personal loan|
|Loan amount||Typically $500 or less||Typically $1,000 – $50,000|
|Loan length||~2 weeks||~2 – 5 years|
|APR||~400%||~6 – 36%|
What to know about payday loans
Payday loans are attractive at first glance, but they should be used just as a last resort after you’ve exhausted all other options.
How do payday loans work?
A payday loan is a short-term loan (aka a check loan or cash advance) that borrowers can get without going through a credit check. Essentially, lenders grant payday loans for small amounts, which borrowers are expected to pay back using their next paycheck along with a fee. So the loan term is very short, depending on when you get paid next.To pay it back, borrowers have to give the lender a post-dated check or grant them permission to take out the loan amount and fees from their bank account on their next payday.
Some borrowers are able to pay back the loan amount in full within the original repayment period, but many end up having to roll over their payday loans into a new loan. This means that borrowers will need to pay a new fee and a cost increase to borrow on top of what they already owe.
Pro tip: Payday loans are often referred to as “predatory loans,” which are loans with unjust terms (i.e., sky-high payday loan interest rates). Predatory lenders sometimes use deceiving loan ads to target people who are desperate for help with their bills or unexpected expenses.
Pros and cons of payday loans
|✅ Offer funding quickly||❌ They’re expensive due to crazy high interest rates|
|✅ Can be used to pay for almost anything||❌ You may sink further into debt|
|✅ Rarely require a credit check||❌ Your bank account can be charged overdraft fees|
|✅ There are a variety of different payday loans available||❌ Lenders can be relentless in debt collections|
Applying for a payday loan
Payday loans can be a very attractive option to borrowers since it’s usually pretty simple to get approved. Most lenders just require borrowers to be 18 years old, have a checking account, provide proof of income and show some identification.
If you apply in person you could get approved and walk out with cash in a matter of minutes. Getting a payday loan online typically takes a few business days.
What to know about personal loans
Compared to a payday loan, a personal loan is a better option to have in your back pocket for emergencies you need to fix.
How do personal loans work?
If a borrower applies for and is granted a personal loan, they can get funded within a few business days. Lenders then require the borrower to repay the loan, plus interest, over an agreed upon repayment term.
Most personal loans tend to be unsecured, meaning they’re not backed by collateral the way secured loans are. Since unsecured loans don’t have that extra layer of insurance, lenders carefully review your credit score, credit history and debt-to-income ratio when evaluating your eligibility and loan terms.
Pros and cons of personal loans
|✅ Usually repaid in fixed monthly installments||❌ If it’s a secured loan, collateral could be seized|
|✅ Don’t always require collateral to be put down||❌ If you overspend, you could rack up more debt|
|✅ Typically have reasonable interest rates compared to payday loans||❌ May have to pay an origination fee at the beginning to take out the loan|
|✅ Can be used to pay for a variety of things||❌ Could hurt your credit score if debt is not paid by the due date|
Applying for a personal loan
Getting a personal loan requires a few more steps compared to a payday loan since borrowers need to apply, and lenders need to run a credit check. To get started, you should check your credit score and credit report to get a rough estimate of your financial health. By doing this in advance, you can get an idea of what kind of loan and terms you’re eligible for.
Once you’ve decided on the loan amount you’d like, shop around for lenders and compare essential details, like the interest rate. Once you’ve finished your research, fill out an application to get qualified.
Alternatives to payday and personal loans
Cash advance program from an employer. Some workplaces offer this low-risk benefit to their employees who need emergency funds. How does it work? If you’re in a tough financial bind, an employer with this program gives you cash or a cashier’s check for a certain amount. To make up for it, the employer withholds a portion of your future paychecks to pay off the loan.
Financial assistance programs from local nonprofits. You may already be aware of organizations in your area that financially help people facing an emergency. Most of these types of loans have fair terms, but they’re only available to individuals who meet certain income requirements.
Credit cards. Credit card companies sometimes offer customers short-term loans with a lower interest rate than a payday loan. Just be sure to use this option carefully. If you don’t pay these back quickly, you could accrue more debt.
So is a payday loan or personal loan better?
When it comes to payday loans and personal loans, we think the latter is objectively better. However, in terms of which one we think you should go with, that’s up to you.
Before signing on any dotted lines, do your research–A LOT of research. Think: what’re all your alternative options? Check your budget, make sure you can afford a loan, and shop around for rates and terms.