Personal Loan vs. Payday Loan: What’s the Difference?
Summary
Personal loans and payday loans may both offer quick access to funds, but they work very differently. See how their costs, terms and credit impact compare.
In this article:
When you need extra money, you might find yourself looking for a loan. You may run across different options, like personal loans and payday loans, to fill the gap. Personal loans and payday loans are very different, and it’s important to understand those differences before making a decision.
A personal loan is an installment loan with a fixed interest rate that you repay in two to five years. A payday loan is for a smaller amount, costs more and is meant to be repaid by your next payday — usually within two to four weeks.1 Not all states allow payday loans.
Knowing how both personal loans and payday loans work before you borrow could help you choose the option that best supports your long-term financial goals.
What is a personal loan, and how does it work?
A personal loan is a type of installment loan that you can use for almost anything, such as an emergency vet bill, a kitchen renovation or debt consolidation. You borrow a lump sum of money from a lender, bank or credit union and repay it with interest (the cost of borrowing). A personal loan has fixed monthly payments and a clear payoff date. OneMain offers personal loans between $1,500 to $35,000 with terms between two and five years. Other lenders may offer different loan amounts and repayment terms.
Lenders, including OneMain, may offer secured or unsecured personal loans.
- Secured loans: A secured personal loan is backed by collateral (something valuable you own, like a car). Applying for a secured loan may help you boost your borrowing power by allowing you to qualify for a higher loan amount, lower interest rate or more favorable terms. If you don’t repay a secured loan, the lender has the right to take the collateral to recover the money you owe.
- Unsecured loans: An unsecured personal loan doesn’t require collateral. Instead, lenders focus solely on your credit history and income when deciding whether to approve your application.
Many lenders allow you to prequalify for a personal loan, which may give you an idea of the kind of loan you might receive if you apply. Checking for prequalified offers takes just a few minutes and doesn’t affect your credit score.
When you apply for a personal loan, the lender may consider factors such as your credit score, credit history, income and debt-to-income (DTI) ratio when deciding whether to approve your application. Your DTI is a percentage that shows how much of your monthly income is used to pay off debts. Typically, lenders prefer that your DTI be below 36%, which suggests that you have enough room in your budget to cover new debt along with your other monthly obligations.2 If you apply for a secured loan, the lender will also evaluate your collateral and its availability to make sure it’s eligible.
Repaying a personal loan as agreed can improve your credit score over time, while missing payments or paying late can hurt it.
What is a payday loan, and how does it work?
A payday loan is a short-term, high-cost loan that typically must be repaid all at once on your next payday, often within two to four weeks.3 Payday loans are usually $500 or less, but the amount may vary depending on the lender.
Payday loan providers usually require you to have:
- A reliable source of income
- Valid photo ID
- An open bank account in good standing
Payday lenders generally don’t check your credit history or your DTI.4 But even though payday loans may be relatively easy to get, they come with a number of risks that are important to understand.
Payday loans come with credit risks. Repaying a payday loan on time likely won’t improve your credit score because payday lenders typically don’t report timely payments to the three major credit bureaus (Equifax, TransUnion and Experian).5 But, not repaying your payday loan as agreed could hurt your credit score. If your loan becomes delinquent, or severely overdue, the payday lender may decide to pass your debt to a debt collection agency. Even if the payday lender doesn’t report your delinquent loan to the credit bureaus, the debt collector might.6
Another risk is cost, as payday loans are very expensive compared to other loans. A typical two-week payday loan may have an annual percentage rate (APR) of nearly 400%.7 APR is the annual cost of borrowing, including fees. A $500 payday loan with a 400% APR could generate an additional $2,000 worth of fees by the end of the year.
If you can’t repay your payday loan in time, you may have to go deeper into debt to meet your obligations, trapping you in a cycle of debt that may be difficult to get out of.
How does a payday loan cycle develop?
A payday loan debt cycle can happen when you can’t repay the full amount you’ve received, along with the fees you’ve been charged, by the lender’s deadline and need to take on more debt to buy more time.
People who can’t repay their payday loan in time often do one of two things: They take out a new payday loan to pay the old one off, or they roll over their loan for another two to four weeks for an additional fee.8 For example, if you borrow $500 with a $75 fee, you'll owe $575 when the loan is due. If you roll over the loan, you may have to pay the $75 fee and another $75 fee for the extension. That brings your total borrowing cost to $150, and you'll still owe the original $500. If you roll over the loan a second time, the total fees would increase to $225, bringing the total cost of repaying the loan to $725.9
If you’re struggling to repay your payday loan (or loans), you’re not alone. A study by the Consumer Financial Protection Bureau found that 80% of payday loan borrowers had to roll over their loans.10 If you find yourself stuck in a payday loan debt cycle, you may consider payday loan consolidation or speaking with a Certified Nonprofit Credit Counselor.
What are some key differences between personal loans and payday loans?
From eligibility to repayment, personal loans and payday loans differ in almost every way. Here’s a side-by-side of some key distinctions.
| Personal loan vs. payday loan | ||
|---|---|---|
| Personal loan | Payday loan | |
| Loan amount | Often between $1,000 and $50,000, but varies by lender11 | Usually $500 or less per loan |
| Repayment term | Two to five years for OneMain, but varies by lender | Two to four weeks or on your next payday |
| How the loan is repaid | Typically repaid in fixed monthly payments | Repaid in one lump sum |
| Credit check | Lenders typically perform a hard credit check | Typically no credit check required |
| Credit reporting | Both positive and negative payment activity may be reported to the major credit bureaus | On-time payments aren’t typically reported to the major credit bureaus, but missed payments may be |
Personal loans typically let you borrow more than payday loans
In general, payday loans have smaller borrowing amounts compared to personal loans — usually about $500 or less. Typically, a personal loan offers access to a higher loan amount — sometimes up to $50,000. The amount you can borrow with a personal loan varies depending on the lender’s requirements, your creditworthiness and your income.
Personal loans give you more time to repay than payday loans
Personal loan repayment terms commonly range from two to five years, depending on the lender. Payday loans must be repaid within two to four weeks or by your next payday, which may not be practical when your budget’s already tight.
Personal loans are repaid with installments, and payday loans are typically repaid at once
As an installment loan, a personal loan is repaid with a series of monthly payments. Payday loans are usually repaid in one lump sum, which can be hard to manage when your finances are already stretched enough to need the loan.
Payday loans typically have higher borrowing costs than personal loans
Personal loans generally have a fixed interest rate, meaning your interest rate stays the same throughout the loan term — and your payments stay the same from month to month if you make payments as agreed. Although personal loans may have fees, such as an origination fee or late fees, they’re generally much lower than the fees associated with payday loans.
Payday loans typically charge fees of $10 to $30 for every $100 you borrow.11 If you can’t repay in time and need to roll over the loan, that cost can quickly grow.
Looking at the APR on a personal loan and a payday loan can give you the full picture of each loan’s true cost compared to the interest rate alone.
Personal loans and payday loans have different credit requirements
Personal loan lenders have stricter eligibility requirements and typically look at both your credit history and financial details before approving your application. Payday lenders are much less stringent and don’t usually consider credit history.
Personal loans can help build credit while payday loans typically don’t
Personal loan lenders generally report account activity, including payment history, to one or more of the three major credit bureaus. When that activity is reported, your on-time payments can contribute to a positive payment history and could potentially help your credit score. Payday lenders generally don’t report on-time payments, so repaying the loan isn’t likely to improve your credit score.
Fast funding doesn’t have to mean high fees
You don’t have to accept the high fees or short repayment terms of a payday loan just because you need funds quickly. With a OneMain personal loan, you could receive funds as fast as one hour after loan closing if you use a bank-issued debit card to receive funds.
Whether you’re considering a payday loan, a personal loan or any other type of loan, review all the details carefully before signing. Make sure you understand the repayment terms, fees and APR. Knowing these details upfront means you’ll be better prepared to repay what you borrow.
Sources
1, 3, 4 https://www.consumerfinance.gov/ask-cfpb/what-is-a-payday-loan-en-1567/
2 https://www.transunion.com/blog/debt-management/what-is-debt-to-income-ratio
5, 6 https://www.consumerfinance.gov/ask-cfpb/can-taking-out-a-payday-loan-help-rebuild-my-credit-or-improve-my-credit-score-en-1611/
7, 8, 9, 11 https://consumer.ftc.gov/articles/what-know-about-payday-and-car-title-loans
10 https://finance.yahoo.com/personal-finance/personal-loans/article/refinance-a-payday-loan-151901744.html
This article is for general education and informational purposes, without any express or implied warranty of any kind, including warranties of accuracy, completeness, or fitness for any purpose and is not intended to be and does not constitute financial, legal, tax, or any other advice. Parties (other than sponsored partners of OneMain Financial (OMF)) referenced in the article are not sponsors of, do not endorse, and are not otherwise affiliated with OMF.
