Payday loan vs. personal loan: What’s the best option?

When you need quick access to money, you have a few different loan options, including personal loans and payday loans.

Personal loans are installment loans with lower interest rates than other credit products, making them a suitable option for many borrowers. By contrast, payday loans are short-term loans that usually come with expensive fees. As a rule, you should avoid taking out a payday loan and only consider them as a last resort.

Here’s what you should know about the difference between personal loans and payday loans, and why you should proceed with caution before signing for a payday loan.

• Payday loan vs. personal loans: What’s the difference?
• Pros and cons of payday loans
• Alternatives to payday loans
• How to avoid predatory lenders

Payday loan vs. personal loans: What’s the difference?

Payday loans and personal loans are both unsecured loans that offer you access to a lump sum of money upon approval. But these loans are more different than they are alike. Here’s a breakdown of the key differences between payday loans and personal loans:

• Borrowing amounts — Payday loan amounts range from $50 to $1,000, depending on the laws in your state. Most payday loans are for $500 or less, according to the Consumer Financial Protection Bureau (CFPB). By contrast, personal loans range from $100 to $100,000 with an average loan amount of around $8,000, according to the U.S. Chamber of Commerce.
• Repayment terms — Personal loan repayment terms generally range from 12 to 60 months (and sometimes longer). Payday loans, on the other hand, usually require you to repay your loan amount (plus fees) with a single lump-sum payment by your next payday.
• Interest rates — The average interest rate on a 24-month personal loan as of the first quarter of 2022 was 9.41%, according to Federal Reserve data. Since interest rates on personal loans are often lower than with credit cards, you can use them to consolidate multiple high-interest credit card balances into one lower monthly payment. Payday loans usually charge a percentage or dollar amount for every $100 you borrow. This fee is commonly around $15, which effectively equals an annual percentage rate (APR) of nearly 400% for a two-week loan, according to the CFPB.
• Impact on credit — If you have a personal loan, your lender will likely report your monthly payments to the main credit bureaus, which can help your credit history if you make your payments on time. Unfortunately, payday loans won’t appear on your credit report unless your account becomes delinquent, which could negatively affect your credit score.

Pros and cons of payday loans

As with most loans, payday loans come with benefits and drawbacks to consider:

Pros

• Easy to qualify — Since payday loans usually don’t require a hard credit check, applicants with below-average credit may qualify.
• Rapid funding — It’s not uncommon to receive payday loan funds within the same or next business day after you’re approved.

Cons

• High fees and interest rates — Loan fees for payday loans range from $10 to $30 for every $100 you borrow for two weeks.
• Rollovers can lead to a cycle of debt — In many states, payday loan lenders can offer you a rollover if you’re unable to pay your loan by its due date. As such, you’d only have to pay the loan fees while the lender extends your loan’s due date — leading to more fees and more debt.

Alternatives to payday loans

You should avoid taking out a payday loan whenever possible. If you need money right away, you have other options, such as:

• Personal loans
• Credit cards
• Payday alternative loans (PALs) offered by federal credit unions
• Home equity loans, or HELOCs
• Loans from friends or family

Personal loans are a less expensive alternative to payday loans. They usually come with lower interest rates and give you significantly more time to repay your loan than payday loans.

If you need emergency cash, personal loans from online lenders can take as little as one day to fund, and lenders can often approve your application within minutes.

Rather than taking out a payday loan, consider applying for a personal loan. Many online lenders allow you to prequalify without affecting your credit. If you don’t qualify for a personal loan, review your other options at that time.

BEST SMALL PERSONAL LOANS

How to avoid predatory lenders

Because of their high interest rates and fees and short repayment terms, payday loans may be considered a form of predatory lending.

Here are some red flags of predatory lenders to look out for:

• Doesn’t reveal APR or fees — The law requires lenders to disclose APRs and fees for their loans, but predatory lenders may make this information difficult to find.
• Negative consumer reviews — Check out lender reviews at the Better Business Bureau, Federal Trade Commission, and Trustpilot to see whether a lender is trustworthy. If the vast majority of reviews you find are negative, you may want to steer clear of that lender.
• No income or credit check — Personal loan lenders typically determine how likely you are to repay a loan by performing a credit inquiry and asking you to submit documents verifying your income. If a lender doesn’t verify your income or check your credit, it could be a sign of predatory lending.
• Encourages repeat lending — Predatory lenders may encourage borrowers to extend their loans or refinance into a new loan, which can trap you in a cycle of debt.

Payday loans almost always come with substantially higher costs and risks than personal loans. With a lower interest rate, longer repayment term, and more significant loan amounts, a personal loan is a better option than a payday loan if you need emergency money.