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Personal Loans vs. Payday Loans: What is the Difference?

Louise Villalobos

ByLouise Villalobos

Jan 22, 2024
Personal Loans vs. Payday Loans: What is the Difference?

If you want to borrow loans, you have several options. For instance, you can take out a payday loan if the lender confirms that you are able to repay it with your next monthly salary, or you can opt for a personal loan. However, it has a longer processing period than a payday loan.

Personal loans and payday loans share some essential characteristics. With both loans, borrowers must return the money within a specific period, and lenders impose interest rates. Borrowers obtain the two types of loans to serve various purposes. A payday lender won’t ask the purpose of the loan, but a personal lender will.

In this article, we will explore the differences between a personal loan and a payday loan. Continue reading to learn more.


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How Does a Payday Loan Work?

A payday loan is a short-term, unsecured loan that any borrower can easily obtain. However, about 25% of US states restrict payday loans as lenders charge high interest rates. Some of the States that have prohibited these loans include Georgia, Arizona, Massachusetts, Colorado, New Jersey, New Mexico, New York, North Carolina, West Virginia, Vermont, Pennsylvania, and Maryland.

Characteristics of Payday loans

Easy to Obtain

You can only secure a small amount of money from a payday loan lender, who usually requests proof of income. Note that you will not be required to provide collateral.

In most cases, payday lenders ask you to allow them to link your bank account with their lending system so they can automatically withdraw funds you owe on the repayment date.

Short Repayment Term

As mentioned earlier, a payday lender expects you to offset the loan using your next paycheck. That means the loan has a repayment term of up to four weeks. If you fail to repay the loan on time, you are likely to get into financial trouble because the lender charges high late payment penalties.

Expensive to Borrow

Payday lenders charge an average interest rate of 400%, which is significantly higher than those imposed on other types of loans. This explains why some states have banned these loans, as they consider them exploitative.

How Does a Personal Loan Work?

After securing a personal loan, you can repay it in installments. Such a loan can be collateralized or non-collateralized and has a longer repayment term and a lower interest rate than a payday loan.

File an Application

To obtain a personal loan, you need to visit the lender’s premises and file a loan application. Once the lender approves your loan request, they will guide you through the loan terms, which include repayment dates, late fees, interest rate, and the amount you qualify to borrow.

Secured or Unsecured Personal Loan

A personal lender who offers secured loans will keep your collateral if you fail to repay the loan. Most lenders ask borrowers to collateralize their loans with financial assets like securities or physical assets like cars or houses.

On the other hand, lenders of unsecured personal loans don’t request collateral but charge relatively high interest rates.

Key Differences Between Personal Loans and Payday Loans

Here are some notable differences between personal and payday loans:

Use – Borrowers who seek payday loans mostly use them to cover emergencies and usually repay them within four weeks. Borrowers of personal loans, on the other hand, obtain these loans to consolidate debt or finance major purchases. They enjoy longer repayment terms.

Cost – Compared to personal loans, payday loans come with higher interest rates, and some have hidden fees, which bring financial burdens to borrowers.

Accessibility – Considering that payday lenders don’t require borrowers to submit multiple documents, it is easier to secure a payday loan than personal loans, which require significant documentation.

Credit score impact – Unfortunately, even if you repay your payday loan on time, it won’t impact your credit score because the lenders do not report the loan to any credit bureau. On the other hand, you can build your credit score if you repay your personal loan on time because the lenders report it to credit bureaus.

Louise Villalobos

Louise Villalobos

Louise Villalobos is an adept writer, renowned for her compelling articles that illuminate and engage. Her prowess in breaking down intricate subjects provides readers with clarity and nuance. With a vast and varied portfolio, Louise has solidified her standing as a distinguished voice in contemporary journalism.