Think all debt is equal? Payday loans and personal loans, for example, may each provide you with funds relatively quickly. But they are quite different.
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). Payday loans do not generally require a credit check. Instead, they are based on proof of employment, identification, and the existence of a bank account. Fees and penalties for late payments can be large.
How is a personal loan different from a payday loan? Like a payday loan, a personal loan is also an unsecured loan. Interest rates are often lower with a personal loan and the amount you can borrow can be much greater. For example, instead of borrowing $500 or less with a payday loan, you can borrow between $2,500 and $40,000 with a Discover® personal loan. You can often choose between repayment terms, so you will have a longer time to pay the loan back than with a payday loan. And because a personal loan can be structured in different ways, it can provide more flexibility and can be used to consolidate debt or pay for life’s big events.
There are other, critical differences between personal loans and payday loans that it may help to know about. Here’s what you need to know about how payday loans and personal loans work.
Table of contents
How do borrowing limits differ between a payday loan and a personal loan?
Payday loans: Payday loans are usually small, short-term loans, with loan amounts ranging from $100 to $500.1
Personal loans: The amount you can borrow with a personal loan varies by lender. For example, Discover Personal Loans offers personal loans that range from $2,500 to $40,000.
What are the fees?
Payday loans: These short-term loans often come with fees or finance charges. Payday loan fees might range from $10 to $30 for every $100 borrowed.2 That does not include any late fees you could be charged if you are unable to repay the loan on time.
Personal loans: Depending on your lender, personal loans can come with their own set of fees. Some lenders charge an origination fee, which 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, that means you will receive only $9,700 but still be required to pay back the full $10,000. Some lenders may also include a prepayment penalty if you pay off your loan before the agreed-upon time period.
The good news is that not all lenders charge origination fees. A Discover personal loan, for example, does not charge any origination fees or prepayment penalties.
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 and interest charges.
How much are interest rates?
Payday loans: Perhaps the biggest potential downside of payday loans is their steep interest rates. For a two-week loan, a $15 fee per $100 is equivalent to an annual percentage rate (APR) of nearly 400%. Plus, there is the addition of late fees to the amount borrowed if you fail to repay the loan in full. You can see how quickly the total interest charges can add up.
Personal loans: Depending on your credit score, personal loans may offer relatively low interest rates. For borrowers with a strong credit history, Discover Personal Loans offers a fixed interest rate from 7.99% to 24.99%. A lower fixed rate, combined with no origination fees, may make personal loans appealing for borrowers.
How flexible are the repayment terms?
Payday loans: Payday loans are specifically 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 and the amount of interest charged. Some payday lenders allow borrowers to roll over a loan for an additional fee.
Personal loans: Personal loans take longer to pay back than payday loans, but they give you a flexible repayment schedule based on your unique financial situation. With many lenders, you can choose from a range of repayment terms so that you can repay your loan in a way that fits your needs. For example, if you get approved for a $15,000 Discover personal loan at 12.99% APR for a term of 72 months, you’ll pay just $301 per month.
But you could structure your loan in a different way, depending on your needs. If your cash flow is limited, for instance, a loan with a longer time frame might be a good fit for your budget because it could lower your monthly payments.
Keep in mind that the longer your repayment takes, the more total interest you will pay over the life of the loan. Or you might choose a loan with a shorter time frame if you want to save money on interest, even though it will likely have higher monthly payments. These flexible repayment terms might give you more control over your budget and a more realistic framework for paying off your loan.
What is the difference between types of lenders?
Payday loans: Payday lenders can help borrowers in case of an emergency. These short-term loans may not require a credit check and could be a financial stopgap for lower-income Americans . But consumers who lack the means to pay back the loan may find themselves in a difficult cycle of unpaid loans and compounding interest rates.
Personal loans: Long-term personal loans are designed as flexible solutions to your financial needs, such as debt consolidation. That’s why they are offered by some of the most recognizable brands in the industry, including Discover. When applying for a personal loan, be sure to read all the fine print. If the lender includes origination fees or closing costs, it might be good to look at other options.
The bottom line
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 or higher interest rates. In contrast, personal loans can offer borrowers a long-term solution that may be easier to manage responsibly. And it can be quick: With Discover Personal Loans, for example, your money can be sent as soon as the next business day after acceptance.*
In fact, Discover Personal Loans gives applicants a same-day decision in most cases . See if you qualify and get started.Check Your Rate
Payday loans are short-term, high-interest loans with payments due that are usually due each payday.
Payday loans typically have a simple approval process that generally requires a government-issued ID and proof of income, such as a pay stub.
Payday loans let you borrow small amounts, usually up to $500.
Fees for payday loans can range between $10 and $30 for every $100 borrowed. A two-week loan that charges $15 for every $100 borrowed, for example, is the equivalent of a 400% annual percentage rate (APR).
Even if you pay back your payday loan in full and on time, payday lenders don’t report your payment history to the credit bureaus. But if you don’t pay back your payday loan, the lender can send your loan to collection. Collection agencies can report your nonpayment to the credit bureaus, which can hurt your credit score.
Consider payday loans generally as a last resort. You might first want to try these alternatives:
Your bank: Some banks are starting to offer small dollar-amount, short-term loans to customers in good standing. Ask yours if that’s an option.
Payment plan: Consider contacting your creditors to extend your loans by reducing your monthly payments.
Cash advance on your credit card: Although a high-interest way to borrow, a cash advance on your credit card might still cost less than a payday loan.
Personal loan: With a lower interest rate and higher borrowing limits, personal loans offer a more affordable alternative to payday loans.