A personal loan and a payday loan will both give you credit when you are a little short of cash. This is why many people believe they are both the same or at least extremely similar in nature and how they work. So are there any differences between the two? Actually, there are many differences.
What is a Personal Loan?
A personal loan is much like a conventional loan, with a key difference. This is unsecured debt, so there is no need for collateral. While applying, you have to submit information about your current income. The lending company will then review your application and decide how much money you can get. There will be a fixed repayment period and interest rate. The repayment term can be for 1 year or more, sometimes up to 5 years. You have to repay every month, plus interest till the end of the term.
What is a Payday Loan?
A payday loan is also unsecured debt, meaning, here too, there is no collateral. You can apply online or offline at the lending office by submitting your personal and income information. The processing time is usually quicker than a personal loan, so you have the money in your bank fast. Payday loans are extremely short-term cash advances till your next payday, as the name suggests. They are usually for a couple of weeks at the most. The amount offered is also lower than a personal loan. Usually, the money offered in payday loans are between $300 and $1500.
Differences Between a Personal Loan and Payday Loan
Difference #1 – The Interest Rate
Let us compare this aspect first, because payday lenders have often been charged for their steep rates and driving their customers into deep debt.
Yes, it’s a fact that the interest rate is higher in a payday loan. The APR or Annual Percentage Rate in payday loans can be 200% or higher. However, do keep in mind that the APR is calculated for the entire year, and not just 2 weeks (which is the typical term of a payday loan), and so the conclusion can be misleading.
The amount you borrow with a payday loan is always smaller, and so it never actually pinches you that much. For instance, if you have taken a payday loan for $100 and have to repay after 10 days, then the outstanding amount on your payday will be $120. The APR here is a staggering 730%, but you still end up paying back just $20 more.
On the other hand, when you take a personal loan, the APR will be much lower. It will be something like this:
Credit Rating: Excellent – 4.29% APR approx
Credit Rating: Good – 4.29% APR approx
Credit Rating: Fair – 10.66% APR approx
Credit Rating: Poor – 25.00% APR approx
So when you take a personal loan of $10000 that is to be repaid in 3 years, you might end up paying back $3000-5000 extra. Many personal loan lenders also sell insurance with the loans. So when you add the insurance coverage, your outflow becomes even more.
Difference #2 – The Collateral
Both personal loans and payday loans are unsecured loans and thus are without collateral. But more and more personal loan lenders are now approving customer requests only when collateral is attached to the borrowing. So there is little chance that you might get a personal loan without collateral these days.
If you are unable to repay the loan for whatever reason, then the lending business will first issue you a notice and will then take away the asset that was the collateral. That will surely be a problem.
In other instances, personal loan lenders ask you to recommend someone who will stand as a ‘guarantor’. So if you default, the guarantor has to pay back the lending company. That will be an embarrassment if you cannot repay.
In a payday loan, on the other hand, there is no collateral or guarantor. Payday lenders issue the loan in good faith. The amount offered is small, and so paying back is normally not a problem. That is why almost everyone pays back the lender, irrespective of what the critics may tell you. Payday loans are the only type of loans currently in the United States that are completely unsecured.
Difference #3 – The Loan Processing Time
Usually, payday loans are processed very quickly. You can apply today and if you have submitted all correct information, the money can be deposited directly into your bank checking account within 2 working days. In some instances, the money can be deposited even on the following business day.
The personal loan may take a long time to reach your bank account. It may take many days and sometimes even several weeks. That’s because, the lender will carry out several checks and consider many things before finally approving your application.
A payday loan is the right solution in an emergency when you must have the cash really quickly. May be you are unable to pay the phone bill and your connected can be discontinued unless you pay in a day or two, or perhaps your car has a mechanical problem and you cannot go to work unless it is repaired fast.
Difference #4 – The Amount
Payday loans are usually issued for small amounts of money, normally between $300 and $1500. Sometimes, the amount involved is even less – just $100. You are also not allowed to take two payday loans at the same time to get more cash. The cash advance here is not to solve your long-term finance issues. It is to solve your immediate cash crunch situation, or solve an emergency situation, like, for instance, paying utility bills, buying medicines, or carrying out urgent car repairs. The lender will not ask you why you have applied for the loan.
A personal loan is to get a much larger amount. It could be $10,000 or even more. Since the amount involved is more, you can solve larger financial issues with this money, perhaps pay off another debt. You may be asked the reason for borrowing, but this is not mandatory. The loan term will vary depending on how much you are borrowing, the interest rate, and the repayment period.
Difference #5 – The Loan Duration
Payday loans are short-term loans, while personal loans may not always be for the short-term. The payday lender will always give you the cash to be repaid on your next payday. So the term is usually for 2 weeks at the most. Technically, however, it could be for up to 30 days, if that is, you have spent all the cash from your last paycheck and must get a loan right after. There is just 1 single payment in a payday loan. Of course, the payday loan you take could also be for less than 2 weeks, perhaps only a week. On your next payday, you have to pay back the sum you borrowed and the interest to your lender. The payment is through automatic debit from your account or a post-dated check.
A personal loan term is for several years. The term can be anything between 1 year and 5 years, and sometimes it is even longer. You have to repay every month as the money borrowed is much larger. There will be several monthly installments, consisting of both the principal and interest.
Difference #6 – Rollover
What happens if you cannot pay back the payday loan on the due date? This is rare, to be frank, because the amount involved is small. But even then, there are always some people who cannot pay back on time, like it is with any other type of loan.
The lending company may agree to a rollover if you are not able to pay back the payday loan on time. You will be charged a fee for this, but you will get a few more days time. It’s like a second chance, and often, this makes a critical difference.
There is, however, no rollover in a personal loan. If you cannot repay, the only option left for you is a debt consolidation. Many lenders now offering personal loans do so only against collateral. So if you cannot repay, there is always the risk that the asset you held as the collateral may be taken away.
Yes, there are a few similarities between payday loans and personal loans. But there are far more differences between them – in the total amount of money you can get from the lender, the term, interest rate, and how quickly and easily you can get the loan, and in other areas as well. All things considered, a payday loan would be a better option for most people, and that is why these loans are becoming so popular, not just in the United States, but all over the world.