Payday Loans vs. Personal Loans: What’s the Difference?

Comparing Sources of Credit

If you need money to cover an emergency, you can borrow it in several ways.

One is a payday loan. This sort of loan is easy to apply for but can be very risky. Payday loans charge high interest rates and often have hidden fees. This makes it very easy to get stuck in a debt trap where it becomes very difficult to pay off your loan, even if you only borrowed a small amount to begin with.

Another option is a personal loan. These loans are a little more complicated to apply for but have much lower interest rates than payday loans. Because of this, personal loans are often used to consolidate debt and are a far safer way to access credit.

Here's what you need to know about the differences between these loans and how you can decide which is best for you.

Key Takeaways

  • If you need money to cover an emergency, you can borrow it in several ways. One is a payday loan, which is easy to apply for but can be very risky. Another option is a personal loan, which is a little more complicated to apply for but has a much lower interest rate.
  • Using a simple online personal loan calculator can help you determine what kind of payment amount and interest rate are the best fit for your budget.
  • Payday loans are almost always more expensive than personal loans when it comes to borrowing money and are riskier as well. If you are eligible for a personal loan, choosing this option will allow you to borrow more money, give you longer to pay it back, and charge you less interest on it.

Payday Loans vs. Personal Loans: An Overview

Payday loans and personal loans have some similarities. With both loans, you borrow money that must be repaid with interest at some future date. Both loans can be used to cover emergencies and to meet the cost of unexpected bills or other financial obligations.

These loans can differ significantly. Payday loans are generally used to borrow small amounts of money until your next paycheck and are very easy to arrange. You won’t need any collateral for these loans, and they can be very expensive. Because of this, they are often considered predatory lending because they carry extremely high-interest rates, do not consider a borrower’s ability to repay, and have hidden provisions that charge borrowers added fees.

Personal loans are a much broader category. This loan is typically offered by a bank, credit union, or online personal loan lender, and you will normally need to provide them with proof that you can eventually repay the loan. Personal loans are normally for much larger amounts of money than payday loans, but you will have much longer to repay this money. The interest rates and fees for a personal loan are much lower than for a payday loan, so the overall cost of borrowing is likely to be much lower.

Warning


Payday loans can charge high rates of interest—up to 400%—and hit you with hidden fees.

Payday Loans vs. Personal Loans

Investopedia / Amelia Manley

How Payday Loans Work

It’s normally very easy to get a payday loan. You can walk into a payday lender’s office and walk out with a loan. You will not have to give anything to the lender in order to secure the loan, as you would at a pawnshop. Instead, the lender will normally ask you for permission to electronically take money from your bank, credit union, or prepaid card account. Sometimes, the lender may ask you to write a
check for the repayment amount, which the lender will cash when the loan is due.

Payday loans can be expensive. Payday lenders charge very high levels of interest: as much as 780% in annual percentage rate (APR), with an average loan running at nearly 400%. Most states have usury laws that limit interest charges to anywhere from 5% to 30%. However, payday lenders fall under exemptions that allow for their high interest. Sixteen states—Arizona, Arkansas, Colorado, Connecticut, Georgia, Maryland, Massachusetts, New Jersey, Montana, New Hampshire, New York, North Carolina, Pennsylvania, South Dakota, Vermont, and West Virginia, as well as the District of Columbia—have outright bans on extremely high-cost payday lending. Seven states—Maine, New Mexico, Ohio, Oklahoma, Oregon, Virginia, and Washington—have imposed a measure of some kind, such as term limits, fee limits, or the number of loans per borrower that provide some protection for consumers.

Payday lenders say that their high interest rates are misleading because if you repay your payday loan on time, you will not be charged high rates of interest. In some cases, that might be true, but 80% of payday loans are renewed multiple times, according to the Consumer Financial Protection Bureau (CFPB), indicating that the majority of these loans are not paid off on time.

Consolidating Debt


You can use a personal loan to consolidate debt. If your credit rating is good, you can often take out a personal loan with a lower interest rate than you'd pay using your credit cards.

How Personal Loans Work

To get a personal loan, you need to apply to a lender. This can be a bank, credit union, or online personal loan lender. Generally, you would first complete an application. The lender reviews it and decides whether to approve or deny it. If approved, you’ll be given the loan terms, which you can accept or reject. If you agree to them, the next step is finalizing your loan paperwork.

When that’s done, the lender will fund the loan, which means paying you the proceeds. Depending on the lender, these may arrive through a direct deposit into your bank account or by check. After the loan is funded, you can use the money as you see fit.

Personal loans may be secured or unsecured. A secured personal loan is one that requires some form of collateral as a condition of borrowing. For instance, you may secure a personal loan with cash assets, such as a savings account or certificate of deposit (CD), or with a physical asset, such as your car or boat. If you default on the loan, the lender could keep your collateral to satisfy the debt.

Personal loans can also be found online. Numerous lenders offer personal loans through their websites. You can apply electronically, get a decision in minutes, and, in some cases, get funding in as little as 24 to 48 hours after loan approval. Using a simple online personal loan calculator can help you determine what kind of payment amount and interest rate are the best fit for your budget.

Lenders can have different requirements when it comes to the credit score, income, and debt-to-income (DTI) ratio that are acceptable to be approved for a personal loan. This can help you narrow down the loans that may best fit your credit and financial profile.

Key Differences

There are several key differences between payday loans and personal loans when it comes to meeting emergency expenses:

  • Cost: Payday loans generally have much higher rates of interest than personal loans and may hit you with hidden fees and charges.
  • Accessibility: Payday loans can be easier to arrange, especially for people with limited credit history and other financial challenges. With some payday lenders, you can even get a loan without a bank account as long as you have a prepaid card account.
  • Impact on your credit score: Most payday lenders don’t report to the credit bureaus. This means that only personal loans show up on your credit report. If you take out a personal loan and make payments on time, your credit score will climb, which will help you qualify for better loans and interest rates in the future.

In almost every situation, a payday loan will be more expensive than a personal loan. If you need emergency money, the best thing to do is to apply for a personal loan to see if you qualify. Then, if you don’t qualify, you can look at other options. Even then, it can be better to spend money on your credit card, ask your employer for overtime, or borrow money from family and friends.

Is a Personal Loan a Better Alternative to a Payday Loan?

In general, a personal loan will be cheaper than a payday loan. Lower-cost personal loans give a borrower more time to pay off a loan than a payday loan does, and most credit unions offer personal loans with APRs comparable to those of credit cards, which still charge lower rates than payday loans.

Are Payday Loans Hard or Easy To Pay Back?

Payday loans are sometimes harder to repay than a traditional loan because the lender did not verify your ability to repay before lending you money. Payday lenders don't generally assess your debt-to-income (DTI) ratio or take your other debts into account before giving you a loan.

Do Payday Loans Help Your Credit?

They probably won't. Payday loans generally aren't reported to the three major national credit reporting companies, so they are unlikely to impact your credit scores. Unless, that is, you fail to pay the loan back on time and you are referred to a debt collection agency, which would hurt your credit score.

The Bottom Line

Payday loans are almost always more expensive than personal loans when it comes to borrowing money and are riskier as well. If you are able to qualify for a personal loan, choosing this option will allow you to borrow more money, give you more time to pay it back, and charge you a lower interest rate. If you need some emergency money, you should first apply for a personal loan.

Article Sources
Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.
  1. Consumer Financial Protection Bureau. “What Are the Costs and Fees for a Payday Loan?

  2. National Credit Union Administration. "Personal Loans: Secured vs. Unsecured."

  3. Consumer Financial Protection Bureau. “Do I Have to Put Up Something as Collateral for a Payday Loan?

  4. Consumer Federation of America. “How Payday Loans Work.”

  5. Conference of State Bank Supervisors. “50-State Survey of Consumer Finance Laws.”

  6. Consumer Federation of America. “Legal Status of Payday Loans by State.”

  7. Center for Responsible Lending. “Map of U.S. Payday Interest Rates.”

  8. Consumer Financial Protection Bureau. “CFPB Finds Four Out Of Five Payday Loans Are Rolled Over Or Renewed.”

  9. Consumer Financial Protection Bureau. "What Do I Need to Qualify for a Payday Loan?"

  10. Consumer Financial Protection Bureau. "I Heard that Taking Out a Payday Loan Can Help Rebuild My Credit or Improve My Credit Score. Is this True?"

  11. Consumer Financial Protection Bureau. "What is a Payday Loan?"

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