Understanding Payday Loans and Personal Loans
Payday Loans vs. Personal Loans: An Overview
Payday loans, a specific type of short-term loan, and personal loans are somewhat similar in that they both can be used to pay for anything; lenders don’t usually care what you spend these loans on. They also both come in lump sums once your loan application is approved, and they usually don’t require any form of collateral.
However, payday loans and personal loans have a range of differences that you need to consider before making an application.
If you’re not sure which type of loan matches your situation and current needs, contact us at Sagemore Financial to discuss your options.
How Payday Loans Work
A payday loan is a short-term loan that the borrower pays back in two to four weeks. It usually comes in modest amounts (around $500 or less) and is notorious for its high interest rates.
What are the qualifications?
To take out a short-term loan, the borrower must be at least 18 years old. They must also provide the lender with a valid government ID and proof of income. This is to ensure that the borrower is capable of paying it back.
Compared to other loans, short-term loans are very easy to apply for, and approval takes very little time as long as you submit all the necessary documents.
What are the terms?
Short-term loans, while easy to apply for, are not exactly cheap. In fact, interest rates can range from 300 to 500 percent. They are typically paid in full upon the borrower’s next pay day which is in 2 or 4 weeks’ time. Lenders usually ask for postdated checks or permission to take payments directly from the borrower’s bank account to make sure they get paid.
Remember that terms for short-term loans may vary depending on the lender. This means interest rates, payment due dates, and the total loan amount can be affected by factors such as state laws, your income, etc.
What is the payday loan cycle?
When the borrower is unable to pay on time, the lender charges late payment fees. The borrower may also request the lender “roll over” or extend the loan. This may help for a short time, but the fees and interest will keep going up, creating a cycle of short-term loans and putting more stress on the borrower’s finances.
Basically, the more you roll your short-term or payday loan, the more fees you’ll have to pay. If unmanaged, you may fall into a debt trap and be in more financial trouble than you were in before you took out a loan.
How Personal Loans Work
A personal loan is also a type of loan that can be used for basically any purpose. However, unlike payday loans, personal loans can allow you to borrow more money (up to $50,000 or more, depending on your lender and state laws).
What are the qualifications?
Personal loan applications have more requirements than short-term loans. To qualify for a personal loan, you will need a good credit score. This varies depending on the lender, but credit scores for personal loans typically fall in the mid-600s or higher.
Besides credit score, your debt to income ratio should not exceed 36% of your total income. Some lenders, however, may allow borrowers to borrow 50% of their total income. Submit proof of income as well as a record of your previous bill payments to prove you can pay your dues on time.
What are the terms?
Personal loans are paid in fixed installments over a period of time. Depending on the amount you borrowed and the agreed arrangement with your lender, you can pay your personal loan in as short as a year or as long as 7 years (or more).
Interest rates are usually between 4 to 36 percent, which is far less than short-term loans (and in some cases, even lower than credit card interest rates). They are also fixed so you will pay the same amount every month.
What are the advantages and disadvantages of personal loans?
Before applying, think about the pros and cons of personal loans and whether or not this fits your current needs.
Advantages of personal loans
- Lump sum payment
- Predictable payments
- Low interest rates
Disadvantages of personal loans
- Multiple fees
- Long-term commitment
- Hard credit inquiry
Key Differences of Payday Loans vs. Personal Loans
The differences between payday loans and personal loans boil down to the following:
How much you can borrow
Payday loan amounts are significantly less than personal loans. Typically, with payday loans, you can borrow between $50 and $1,000. Meanwhile, you can borrow up to $100k with a personal loan depending on the lender, your credit score, and income
Payday loans, as their name suggests, are paid upon the borrower’s next paycheck (usually in 2 weeks). Meanwhile, personal loans are paid between 2 and 7 years (or more), and the payment terms heavily depend on your agreement with the lender. They will look into different factors that will affect your loan terms, such as your credit score, income, and other proofs of creditworthiness.
The most expensive loans are payday loans, which have fees that range from 300 to 500 percent. Meanwhile, personal loans have lower interest rates. In fact, some personal loans can have interest rates lower than credit card charges.
Ability to build credit
Since payday loans are minuscule in comparison to other types of loans, lenders do not report your payday loans to the credit bureaus. As a result, they cannot help build your credit. Personal loans, on the other hand, are reported to the credit bureaus, which helps build credit.
Applications for payday loans are significantly easier and faster than personal loans. Because payday loan amounts are low and the requirements (identification and proof of income) are easy to submit, your payday loan application can get approved within an hour (or less).
Applications for personal loans, on the other hand, require a more thorough review of the applicant’s financial situation. Lenders will review your credit history before approving the amount and setting your terms.
Loan repayment terms
Short-term loans are ideally short-lived. You are expected to pay your loan in full upon your next paycheck. Lenders can request a postdated check or authorization for automatic deductions from your bank account.
Meanwhile, personal loans are paid in installments over an agreed-upon period of time. You can also set up automatic payments through your account so you don’t have to worry about meeting your dues. Your payments are streamlined.
Is a Personal Loan a Better Alternative to a Payday Loan?
Personal loans are cheaper than payday loans, and they build credit. However, payday loans are faster to apply for, especially when the borrower has a low credit score.
Are Payday Loans Difficult or Easy To Pay Back?
Although payday loans are smaller in amount, the interest fees can be very high. Because lenders don’t do a thorough background check for short-term loans, some borrowers who cannot afford to pay end up getting approved anyway.
At the end of the day, the difficulty of paying back short-term or payday loans really just depends on the borrower. The longer the loan is stretched, the higher the amount to be paid because of the buildup of interest and other fees.
Do Payday Loans Help Your Credit?
Payday loans cannot help build your credit score. That’s because lenders don’t usually report payday loans to the credit bureaus. However, if you fail to pay the payday loan on time, a debt collection agency may come in between you and the lender, which will affect your credit negatively.
Which Loan Is Right for You?
Understanding which loan is right for you comes down to what you need it for and how qualified you are to get either loan.
If you’re thinking about getting a larger loan without getting charged high interest rates, personal loans will be your best bet. However, borrowers will need to meet a few requirements before approving your application, such as a credit score that is not below the mid-600s and proof of your ability to pay. If you don’t qualify for a personal loan, you can still consider a short-term loan.
You must be wary, however, of delayed payments and payday loan “rollovers.” This can balloon your fees, making them even harder to pay back.
Understanding What Type of Loan is Best for You
When needed, it’s not a bad idea to seek financial help from lenders. In fact, it can relieve stress and unnecessary financial burdens.
Borrowing money is not harmful in and of itself, but it is important to know how to borrow money wisely. This is why consulting a trusted lender is important before making any financial decisions, like applying for a loan. You want to apply for the type of loan that matches your current situation and your current capacity to pay.
If you want to know more about the different types of loans, how to apply for them, or how to know if you’re qualified for a loan, talk to us at Sagemore Financial. We have an experienced team of financial managers who can help you explore the options that fit your needs.
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