If you’re on the hunt for some quick cash to cover an unexpected expense, chances are you’ve come across a mountain of lenders offering either payday loans or personal loans.

With so many options, it can be difficult to discern between these two types of loans, especially if you’re new to the personal finance market. However, knowing the key differences between the two can really help you decide which works best for your individual financial needs.

What is a payday loan?

A payday loan allows you to borrow a small amount, typically up to $2,000, which can be repaid via a short-term repayment schedule between 16 days and one year. Payday loans, or cash advance loans, are unsecured which means they have no collateral or assets backing them.

Qualifying for a payday loan is quite simple, with the minimum requirements usually being 18 years or older, having a valid form of ID, an open bank account, and proof of employment. Therefore, these types of loans are usually designed for borrowers with poor credit and limited access to traditional lenders like banks.

Payday lenders are unable to charge interest on payday loans due to government regulation, however, they can charge fees including:

• Establishment fee: 20% of the amount borrowed
• Monthly service fee: 4% of the amount borrowed
• Government fees or charges
• Default fees or charges (cannot be more than two times the amount borrowed)
• Enforcement expenses (the costs of going to court to recover the money owed)

What are personal loans?

Compared to a payday loan, personal loans are typically a larger amount that is repaid over a longer period of time. Personal loans can be taken out from a bank, credit union, or an online lender. They are often used to purchase assets like vehicles or furniture, pay for medical expenses, or home improvements as well as cover car repairs or to consolidate debts.

Some lenders offer ‘bad credit personal loans’ so if you’re a borrower with a poor credit history, don’t let this deter you from applying for a personal loan.

Personal loans can be secured to an asset you own, like a vehicle or your house, or it can remain unsecured. Personal loans that do have security or collateral behind them typically come with lower interest rates than unsecured loans.

Fixed vs. variable interest rates: what’s the difference?

Another factor to consider is that interest rates can be either fixed or variable, which is something to compare when applying for a personal loan.

A fixed rate is a rate locked in at the start of your loan term and kept in place throughout the duration of your loan contract. This type of interest rate is offered by most lenders and enables you to accurately budget as you’ll know exactly how much you’re paying each month.

Variable interest rates tend to fluctuate so while you can save when rates fall, you may be offered a higher base rate.

What’s the difference between payday loans and personal loans?

So a payday loan vs a personal loan, what’s the difference?

There are some key factors that differentiate payday loans and personal loans from each other, so it’s important to consider these before taking out a loan:

• Loan amounts: Payday loans are usually designed for smaller amounts, while the amount of money you can borrow with a personal loan is typically higher.
• Fees and charges: When comparing loan costs, payday loans are often seen as a high-cost alternative to personal loans, due to the high fees applicable to this loan type. However, personal loans may still come with some fees and also with a fixed or variable interest rate for the duration of the loan.
• Repayment period: Personal loans also offer longer repayment terms so repaying the loan may be more budget-friendly.
• Eligibility: In some cases, payday lenders have more flexibility when it comes to their eligibility criteria compared to traditional personal loans. However, there are some inclusive personal loan lenders who consider more than just credit scores when applying for a loan. So don’t let your poor credit history hold you back from applying.

What should I consider when taking out a loan?

Before you decide to borrow money from a payday or personal loan lender, you should consider your current financial situation. Ask yourself the following questions before taking out a loan:

• How much do I need to borrow? If you only need to borrow a small amount, a payday loan may be suitable. However, if you need to borrow over $1,000 – this is where a personal loan lender might be able to lend a hand.
• How quickly do I need the funds? With an increase in online lenders in both the personal loan and payday lending market, many lenders offer fast transfers straight into your bank account once approved.
• How much can I afford? Short-term payday loans often come with high fees and a shorter repayment period. You’ll need to do your own budgeting to ensure you can pay the loan back on time, including any associated fees, to avoid becoming a part of a ‘debt spiral’ many payday loan borrowers can find themselves in. Many personal loan lenders offer a repayment calculator so you can see if the projected repayments will be manageable. However, these repayments can depend on a number of factors, including your loan amount.
• What is my credit history like? For borrowers with bad credit, payday loans are often a go-to loan option due to their flexible eligibility criteria. However, with more online personal loan lenders offering inclusive loans to bad credit borrowers, a high-cost payday loan doesn’t always have to be your last resort. It’s important to shop around to see which personal loan lenders offer a bad credit loan that suits your financial needs.
• What do I need the money for? A personal loan is often used for larger expenses such as car repairs, home improvements, or holidays. On the other hand, payday loans are often smaller amounts used for unexpected expenses.

Once you’ve considered these questions, you can be well on your way to finding the right personal finance option to suit your financial needs.