Payday versus personal loan scale.

Payday Loans Versus Personal Loans

Are you interested in taking out a cash loan? If so, you have probably come across both payday loans and personal loans. Take a look at the differences between these two very distinct types of loans.

Payday Loans

A payday loan is a very short term loan that is for a very low dollar amount. Loans are for amounts well under 1000 dollars with the average loan being just over 300 dollars. These are generally low or poor credit loans and are often a last resort of emergency money for many people.

Loan Rates & Terms

Most payday loans do not charge interest but instead charge a set fee. This can still be expressed as an interest rate however. An Annual Interest Rate is a representation of the actual interest rate taking into account all of the fees and charges involved with a loan. When expressed as an APR, most payday loans have rates well in excess of 400 percent.

As far as terms go, they are very short. The maximum term of one of these loans is 30 days but most of them are for under 14 days. This is where the term payday loan comes from because it is supposed to be paid back on the borrowers next payday.

Who Should Use A Payday Loan?

So, who should use one of these loans? Nobody really. They are a loan of last resort for those that do not have access to traditional or mainstream financing. If you absolutely need money and have no other way to get it, then you might consider one, but only then.

As far as benefits go, the only one that you get with a payday loan is money to handle a problem. After that, you have a short loan term and very high loan fees. If you pay the loan off successfully, you don’t even get a boost on your credit score. Payday loan companies generally do not report positive information to the major credit bureaus.

Another real problem with payday loans is what is called the “payday loan trap”. This is what happens when people get caught in a seemingly endless loop of payday loans. Here is an example. Jane borrows 300 dollars with fees of 20 bucks per hundred borrowed. She is then due to repay that loan in 14 days and the total amount due is 360 dollars.Simple, right?

The problem is that she is already living paycheck to paycheck and can not afford to pay the loan back. So, she instead pays the fees of 60 dollars and renews the loan. This means that she once again owes 360 dollars in two weeks. Guess what happens. She once again can not pay the loan back and must renew it again. This goes on and on and is “the trap”.

Personal Loans

Personal loans are generally more of a mainstream loan. Although there are lenders who work with bad credit in this segment, personal loans are also offered by local banks and credit unions. There is also a large network of online lenders willing to make personal loans, even with less than perfect credit.

Most of the time, a personal loan will be unsecured but you can also take out a secured loan using a home, auto or other tangible property as collateral.

You can take out a personal loan for just about anything, but one of the biggest reasons that people open one is to consolidate debt. With credit card interest rates as high as 29 percent, rolling these balances into a lower interest loan can result in serious savings.

Loan Rates & Terms

Personal loans will often charge both interest and fees. This is where the APR measurement can be helpful when determining the true cost of a loan. The APR takes into account the loan term, fees, charges and interest. Every dollar that you would pay to the lender is considered to give you an Annual Percentage Rate.

APR’s can vary quite a bit for this type of loan. The rate that you receive will depend on a number of factors. Your lender will look at your credit rating, loan amount, loan length, your income, etc, etc. They will use all of this information to come up with a loan offer.

As far as the loan term goes, this can vary quite a bit as well but it is typically for a term that is much longer than what a payday loan offers. It can be anywhere from a few months to many years.

Who Should Use A Personal Loan?

This type of loan is appropriate for many different types of people and many different circumstances. Generally, if your credit is good and you can qualify for a low rate, a personal loan might make sense.

If you are in need of debt consolidation, looking to renovate your home or looking to fund a child’s education, they can be very useful.

If you have bad credit, a personal loan might still be useful. Some lenders will offer personal loans to the sub prime market and the terms are often much better than what you would get by going the payday loan route. In addition, many lenders, even in the sub prime market, may report a positive payment history to the credit bureaus. This could allow you to improve your score.

Wrapping Up

As you can tell, there are quite a few differences between a payday loan. Payday loans are generally low dollar, high interest and short term. Personal loans in general are for higher dollar amounts, longer terms and often have much better rates.

If you have to decide between the two, most of the times the personal loan will be the better option. Be sure to compare the APR of each loan before making a final decision.

Another thing to consider is if the cost of the loan is worth the benefit received. Consolidating high interest credit card debt into a lower interest rate loan is a no brainer, but other loans are not so clear. For example, is it worth paying on a 4000 dollar loan for 5 years to take a one week vacation. Make sure the benefit outweighs the cost before proceeding, especially if you have less than perfect credit.

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James Car is a finance, loan and budget expert based in the United States. After attending Brookhaven college, he went on to become a successful entrepreneur. He now enjoys writing articles that help people save and make the most of their money.