Payday Loans vs. Personal Loans: Which is Better?

When you are in a situation where you need a loan and think that turning to any of the approximately 23,000 payday lenders in the U.S. — almost twice the number of McDonald’s restaurants — is a good idea, think again.

Debt is easy to get into and hard to get out of, just like any other trap.

What is a payday loan?

Payday loans are short-term, high interest, low limit loan amounts, usually around $500, that help cover immediate, emergency cash needs that are meant to be repaid at your next paycheck. The average interest loans on these loans are 391% for a 14-day loan.

How do payday loans work?

Loan amounts vary from $50 to $1,000, depending on the law in your state. The interest rate will also vary by state. If approved, you receive cash on the spot or within 1-2 business days.

Payday loan qualifications

  • Applicant must be at least 18
  • Have a government-issued ID or Social Security number
  • Have a steady job or another source of income
  • Have a bank account

Pros

There’s no credit check

Payday loan lenders won’t check your credit report with the three major credit bureaus, so you’ll still qualify even if you have bad credit or your credit score is less than perfect. All you need is an ID and proof of income.

They’re easy to access

Fast and easy is the draw for this type of loan. But fast and easy doesn’t mean cheap.

It’s an unsecured loan

An unsecured loan means that it doesn’t require any collateral. The lender approves you based on your job or source of income.

Fewer requirements than traditional financial services

There are few requirements for this type of lending, unlike traditional banks with rigorous document requirements and underwriting before getting loan approval.

No credit check, so credit history doesn’t matter

Since there is no credit check, they look for a bank account where they can debit funds and a job that gives you a paycheck that gets deposited in that account.

Cons

They’re expensive

They have very high fees, and annual percentage rates make it a high-cost loan. Rates can range from 391% to over 600%. Repayment on the next payday makes it challenging to come up with enough money to repay the total amount of the loan as scheduled, creating a debt trap for the borrower.

Small loan amounts

These loan amounts range from $50-$1,000, which doesn’t get you far these days.

You have to give payday lenders access to your bank account

Providing access to the payday lenders to your bank account means that your loan would be automatically debited from your salary account when your salary is deposited.

You could end up in court

If you do not pay your loan or are unable to pay it, the lender can take you to court to recoup the funds. You cannot go to jail for an unpaid loan, but you can if you decide to ignore the judge’s court summons.

You could end up dealing with a tribal lender

Payday loans are outlawed in several states, but that doesn’t mean they’re impossible to obtain. Tribal lenders can sidestep state laws due to what’s known as “tribal sovereign immunity.” Native Americans have special legal privileges (it’s hard to sue them) and can largely govern themselves. This means that almost every law that’s been put into place to protect borrowers does not apply.

You could get stuck in a cycle of debt

Payday lenders’ business models rely on making loans borrowers cannot pay back without reborrowing – sometimes up to an average of 9 times, and paying even more fees and interest, so you get stuck in the debt trap.

Payday loans don’t help build credit

Payday loans do not report to the three leading credit reporting companies, Experian, Transunion, and Equifax. Therefore this type of loan will not help you build credit. Still, it can ruin your credit if you cannot pay.

What is a personal loan?

A personal loan is a loan from a bank, credit union, or online lender. These loans are issued in a lump sum and deposited into your bank account. They are considered a form of installment credit. It is repaid in fixed monthly payments, usually over two to seven years.

Personal loans can be secured or unsecured loans. Secured loans are like a mortgage where the house acts as collateral for the loan or a car title for a loan.
An unsecured loan doesn’t involve any collateral. The only assurance a lender has that you will repay the debt is your creditworthiness and your word. These can be student loans and credit cards. These are considered higher-risk loans.

How do personal loans work?

Unlike a credit card, personal loans deliver a one-time lump sum cash payment to borrowers. Then, borrowers pay back that amount plus interest in regular, monthly installments over the loan’s lifetime.

You will need to complete an application form, and each lender will have their application form, which can look different from lender to lender. They will be pulling a tri-merge credit check from the big three credit reporting companies.

​Personal loan qualifications

Lenders want to be sure that you can pay back the loan. In addition to your credit score, lenders will consider your income, work history, assets, and debt-to-income ratio.

Pros

More flexible repayment terms

It is repaid in fixed monthly payments at a fixed interest rate over a specified time. You can choose your length of loan repayment. The longer the life of the loan, the lower the payment, but the loan cost is more expensive since you are paying into the interest for a much more extended time than paying down the principal.

Lower interest rates

It has a much lower interest rate than any payday loan.

Higher borrowing limits

These loans have higher borrowing limits and are more practical than the $500 limit that most payday lenders can lend.

There are options for both unsecured and secured loans

There is flexibility to apply for a secured or unsecured loan based on what fits your purpose or goal.

They’re simpler to manage

A single monthly payment to manage instead of several credit cards works excellent for debt consolidation.

Monthly payments

Your fixed-rate monthly payments are predictable and are reported to the three credit reporting companies, which can help boost your credit.

Cons

Most lenders require a credit score of 660

These types of loans are for people with excellent credit. They will get the best loan offers and lower rates. You’ll pay a much higher annual percentage rate if your credit score is lower. If you are using this for credit card consolidation, you need to qualify for a low enough interest rate for actual savings, and not just for the convenience of having to pay one payment.

Higher interest rates than other alternatives

Some personal loans can have higher interest rates than others, but all will have lower APRs than any payday loan out there.

​Fees and penalties can be costly

Loan origination fees can be 1%-6% of the total loan amount, the pre-payment penalty fees can be 2%-5% of the loan amount, and late payments can be $25-$50 or 3%-5% of the monthly payment.

Monthly payments will be higher than credit cards

Since a personal loan has a set term of 36 months, it generally requires higher minimum payments than a credit card. The higher monthly payments of a personal loan may be harder to manage for individuals with limited disposable income.

You might have to pay an origination fee

An origination fee is paid to a lender to process a loan application. The borrower agrees to pay this upfront fee to the lender for setting up the loan or mortgage.

They can increase debt

Because you are taking on debt, it can increase your debt, but using a personal loan to pay off revolving-credit debt could lower your credit utilization or debt-to-income ratio.

There are a lot of scammers

According to the Federal Trade Commission, about $3.3 billion was lost in loan fraud in 2020. It isn’t always easy to identify a scammer, because many have devoted a lot of time and resources to their sales pitch in order to make it sound legitimate. Protect yourself by learning the warning signs.

Payday loans vs. personal loans: Which is better?

An unsecured personal loan will always be better than a payday loan. With payday loans averaging 400% APR, any loan is better than a payday loan. And payday loans lead to regret. About 93% of payday loan borrowers end up regretting their original payday loan. The only exception would be when you know you have a payment on the way within days (a tax refund, for example) and you have an emergency expense that cannot wait. Otherwise, a personal loan will always be a safer option.

Do you feel trapped by payday loan debt? Here are a few strategies to help you escape:

Better types of loan options for people with bad credit

Installment loan

Personal loans can be installment loans that allow individuals to borrow a predetermined amount of money, disbursed in a lump sum, and repaid over time. These loans come with a fixed interest rate and require regular monthly payments that remain the same each month.

Cash advance apps

Cash advance apps can allow you to tap into earnings already worked for earlier than actual payday. They are a digital equivalent of a payday loan provider known as earned or early wage access apps. Cash app fees aren’t as high as typical payday loans and are a fast, convenient way to get extra cash or cover the short.

Payday Alternative Loan (PALs)

Credit unions offer PALs, which cost considerably less than a payday loan. It allows 12 months to repay, and loans can be up to $2,000. The maximum APR is 28%, with an application fee of no more than $20. Depending on the credit union, you have to be a credit union member for at least one month or six months. You can receive a maximum of three loans within six months. Most don’t require good credit but just the borrower’s income and ability to repay the loan.

Debt consolidation loan

Debt consolidation loans combine multiple high-interest rate debt into a loan with a lower interest rate. Consolidating a payday loan into a personal loan may be a good option.

Credit card

Get a cash advance from your credit card. You are borrowing money against your card’s line of credit and can be as simple as heading to the ATM. You will be paying a higher interest rate than what you pay for purchases, but it is better than what any payday lender charges you.

Home equity loan or home equity line of credit

This loan uses a percentage of equity in your home to get cash and is a line of credit secured by your home. If you’ve made home improvements, you may be able to borrow more than you think.

The bottom Line

A payday loan is a temporary, last resort solution to what is often a longstanding financial problem, and it’s something you should avoid in the future.

Start by improving your credit to prepare for an emergency so that you can apply for a more suitable personal loan in the event the need arises.

FAQs

Why does my credit score matter?

Your credit scores are an essential part of your financial health. You want good credit scores because they can unlock many savings and benefits and determine your job and housing. Your credit score will decide whether or not you’re offered a credit card or loan, assess your credit limit, and the interest rate you’ll pay.

What is the Consumer Financial Protection Bureau?

The CFPB was created to provide a single point of accountability for enforcing federal consumer financial laws. It protects consumers from unfair, deceptive, or abusive practices and takes action against companies that break the law. They also arm people with the information, steps, and tools that they need to make intelligent financial decisions.

Should I consider credit counseling?

You should consider credit counseling if you’re having trouble making your debt payments or if you’re currently past due on your balances. Reputable credit counseling organizations can advise you on managing your money and debts, help you develop a budget, and offer free educational materials and workshops. Even if you don’t enroll in a debt management plan, a credit counselor can help you create a budget and advise you on managing your debts.

Scroll to Top