Did you know that not all debt is equal? For example, personal loans and payday loans, two common loan options, may provide you with funds quickly. But they are quite different when it comes to loan flexibility, repayment terms, and potential fees.
Deciding on a payday loan vs. a personal loan may depend on your financial situation. As you consider your options, be sure to weigh the benefits and drawbacks of each.
Here’s what you need to know about how payday loans differ from personal loans. .
What is a payday loan?
A payday loan “is usually a short-term, high-cost loan, generally for $500 or less, that is typically due on your next payday,” according to the Consumer Financial Protection Bureau (CFPB).
How does a payday loan work?
A payday loan usually provides quick cash without requiring a credit check. Payday loans are offered online and typically lenders require payment in full on the borrower's next payday. Fees and penalties for late payments can be large.
Eligibility requirements are typically limited to a photo ID, a valid bank account, and proof of a regular paycheck.
What is a personal loan?
A personal loan is a lump sum of money you borrow to pay for a variety of expenses and/or to pay off a higher-rate debt. It is a form of an unsecured loan, typically issued by a bank, online lender, or credit union and may allow borrowing up to $100,000. Personal loans usually offer a fixed rate and fixed loan term. You repay those funds in one set regular monthly payment over a period of time.
Unlike a payday loan, a personal loan application will require a credit check. Your credit score is an indicator of your financial health and having a higher score may help you qualify for larger loans and smaller interest rates. Additionally, your lender will ask for proof of identity and proof of address, as well as employment and income verification.
What fees are associated with payday loans and personal loans?
Payday loans fees
Short-term payday loans often come with high fees or finance charges. Payday loan fees might range from $10 to $30 for every $100 borrowed for just a few weeks or less.1 That does not include any late fees you could be charged if you are unable to repay the loan on time.
Personal loans fees
Depending on your lender, a personal loan may have fees. Some lenders charge an origination fee that is deducted from your loan amount when you take out the loan. A 3% fee might not sound like much, especially compared with payday loans. But if you are charged 3% on a $10,000 loan, you will receive only $9,700 but will still need to pay back (and pay back interest on) the full $10,000. In addition, some lenders may charge a prepayment penalty if you pay off your loan before the repayment term ends.
A Discover personal loan, for example, does not charge any origination fees or prepayment penalties. In fact, there are no fees at all.
What is the cost of borrowing for payday loans and personal loans?
Payday loans
Perhaps the biggest potential downside of payday loans is their steep cost of borrowing. There are typically no traditional interest payments, but fees may be costly. For a two-week loan, for example, a $15 fee per $100 is equivalent to an annual percentage rate (APR) of nearly 400%. Plus, you could incur late fees if you fail to repay the loan on time. These fees add to your debt. You can see how easy it is to get caught up in a serious debt cycle with this type of borrowing.
Personal loans
Depending on your credit score, personal loans may offer relatively low interest rates, particularly when compared to other types of borrowing. Late fees might also apply. For borrowers with a good credit history, Discover Personal Loans offers a fixed interest rate from 7.99% to 24.99% APR, in addition to no fees of any kind. It’s a good idea to compare lenders and note any difference between the interest rate and the APR on a personal loan you may be considering—the latter factors in additional fees charged by the lender.
Which type of loan has more flexible repayment terms?
Payday loans
Payday loans are designed for short-term use. These loans are typically due at the time of your next paycheck. Failing to repay the loan within that term could result in extra fees. If you are not ready to repay the loan, some payday lenders allow borrowers to roll over a loan for an additional fee.
Personal loans
Personal loans give you a flexible repayment schedule based on your financial situation. With many lenders, you can choose from a range of repayment terms to fit your budget. At Discover Personal Loans, you can choose how long you’d like to repay your loan—from 36 up to 84 months. For example, if you get approved for a $15,000 loan at 12.99% APR for a term of 72 months, you’ll pay just $301 per month.
If your cash flow is limited, you might prefer a loan with a longer repayment term, which would lower your monthly payment. Or you might choose a loan with a shorter term if you want to save money on interest. This could, however, result in higher monthly payments. Try Discover’s personal loan calculator to find the best repayment term for your budget.
Can payday loans and personal loans affect your credit?
Payday loans
A payday loan is unlikely to help you strengthen your credit history. Even if you repay it in full and on time, payday lenders typically don’t report your strong payment history to the credit bureaus. If you default, however, your loan can go to collections. That may be reported to credit bureaus, hurting your credit score.
Personal loans
A personal loan can help you build your credit history. On-time payments are reported to credit bureaus, which positively affects your credit. In addition, having diverse credit accounts in good standing shows that you can manage a credit mix responsibly, which is factored into your credit score.
What are major differences between these loan options?
Payday loans
Payday lenders may help borrowers in case of an emergency. These short-term loans do not typically require a credit check. They may be a financial stopgap for lower-income borrowers. But consumers who lack the means to pay back the loan may find themselves in a difficult cycle of unpaid loans and compounding fees.
It’s important to know the terms of the loan agreement. In some states, payday lenders may allow you to extend the loan term when it becomes due. Some lenders may let you repay the loan in installments over a longer period of time. Some states do not permit payday lending at all.
Personal loans
Personal loans are designed as long-term, flexible solutions to your financial needs, such as debt consolidation. That’s why they are offered by some of the most recognizable financial services brands, including Discover.
Loan agreements may differ between lenders, so be sure to read the fine print. If the lender includes origination fees or closing costs, it might be good to look at other options. With Discover Personal Loans, you’ll pay $0 origination fees, $0 closing fees…no fees of any kind.
What are the advantages of a personal loan?
Both personal loans and payday loans can be used for financial emergencies. But payday loans may lead to a damaging cycle that makes it difficult for borrowers to catch up because of expensive fees.
In contrast, personal loans can offer borrowers a long-term solution that may be easier to manage responsibly and may help build financial wellness. And it can be quick. And it can be quick. With Discover Personal Loans, funds can be sent as soon as the next business day after your acceptance.
In fact, Discover Personal Loans gives same-day decisions in most cases. See if you qualify and get started.
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The information provided herein is for informational purposes only and is not intended to be construed as professional advice. Nothing contained in this article shall give rise to, or be construed to give rise to, any obligation or liability whatsoever on the part of Discover, a division of Capital One, N.A., or its affiliates.
1 https://www.consumerfinance.gov/ask-cfpb/what-is-a-payday-loan-en-1567/