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

When you take out a personal loan, you typically borrow between $1,000 and $50,000 and pay it off in installments over several years. Payday loans, on the other hand, are small, high-interest loans — around $500 or less — that you usually have to repay within two to four weeks. Payday loans tend to be risky, because they come with high fees and interest charges that can trap you in a cycle of debt.

Read on for a comparison of personal loans versus payday loans, and learn why you should think twice before borrowing a payday loan.

Personal loans vs. payday loans: What’s the difference?

Personal loans and payday loans can both be used to pay for virtually anything — plus, when you take out one of these loans, you’ll receive a lump-sum of money if you’re approved. But that’s about where the similarities end and the sharp differences begin.

See the table below for a quick look at the differences between payday loans and installment loans:

Six main differences

1. How much you can borrow
2. How long you can borrow it for
3. Interest rate
4. Ability to build credit
5. Loan application
6. Loan repayment

How much you can borrow

Most personal loan lenders let you borrow between $1,000 and $50,000, but some have higher caps at $100,000. Payday loans, meanwhile, are typically small-amount loans that max out at $500.

How long you can borrow it for

You usually have three to seven years to pay back a personal loan, though some lenders may offer shorter or longer terms. If you borrow a payday loan, however, you’re often expected to repay it in full within two weeks.

Interest rate

Personal loans have much lower interest rates and fees than payday loans. If you have strong credit, you might be able to qualify for an interest rate in the single digits.

Payday loans, on the other hand, can have extremely high interest rates and fees that could add up to an APR as high as around 400%. Payday loans can be considered predatory and dangerous for consumers because their rates and fees are so high.

Ability to build credit

Personal loans can help build credit if you make on-time payments over time. Payday lenders, however, typically don’t report your on-time payments to credit unions. However, they will report missed payments — in fact, defaulting on loans could damage your credit.

Loan application

Many banks, credit unions and online lenders offer personal loans. Some let you prequalify online, meaning you can check your rates with no impact on your credit score. This option to prequalify also lets you shop around and compare offers.

If you find one you like, you’ll submit a full application, typically with supporting documentation, such as pay stubs. The lender will also check your credit at that point.

To borrow a payday loan, you would apply with a payday lender. The lender likely won’t check your credit, but it might collect your bank account information.

Loan repayment

With a personal loan, you pay it back in installments on a monthly basis. You can set up automatic payments through your online account.

With a payday loan, you’re typically expected to repay the loan when you get your next paycheck. The lender might automatically withdraw the funds from your account if you’ve provided your bank account information or a check.

Since many consumers can’t afford to pay back the payday loan and its associated fees, they end up taking out another payday loan to cover the first one. These roll-over loans can lead borrowers to getting trapped in a cycle of debt.

How personal loans work

When a borrower takes out a personal loan, a lender gives them a lump sum of money. The loan is repaid with interest in fixed payments over a set period of time, typically a few years. See an example of personal loan monthly payments below:

Personal loans are typically unsecured, which means they don’t require you to put up collateral. Because of this, lenders rely heavily on your credit score and debt-to-income ratio when determining eligibility and APRs.

Some lenders offer secured personal loans backed by an asset you own, like your home or your car. Secured personal loans may be a viable option for lower-credit borrowers, and they typically come with lower APRs than unsecured personal loans. However, you risk losing that asset if you default on the loan.

Benefits of a personal loan

Personal loans are repaid in fixed monthly payments. Your monthly payment will stay the same, so you’ll always be able to budget for how much you owe.

Personal loans may not require collateral. By taking out an unsecured personal loan, you don’t risk losing an asset you own, like your car or your home.

Personal loans can be used for many reasons. You can use a personal loan to finance virtually anything, including:

Personal loan pitfalls

Avoid taking out an expensive personal loan. Personal loan APRs can run high, particularly for borrowers with bad credit. The higher the APR, the more the loan costs.

Avoid borrowing more than you can repay. If you can’t repay your personal loan, you risk ruining your credit score. For secured loans, you also risk losing the asset you used as collateral.

Avoid paying fees and penalties. You may incur an origination fee ranging from 1% to 8% when you borrow the loan, or be charged a prepayment penalty for paying off the loan early.

Applying for a personal loan

1. Check your credit score. This will give you a better idea of what loan terms to expect. You can check your credit score for free on LendingTree Spring, as well as shop for loans and more.
2. Calculate how much you need to borrow. If you don’t borrow enough, you may come up short for a necessary purchase. Borrow too much, and you’ll pay interest on money you didn’t need.
3. Prequalify with lenders. Many lenders let you prequalify with a soft credit inquiry, which won’t affect your credit score.
4. Compare APRs, and choose the best offer. Typically, you’ll want to choose the personal loan that offers the lowest APR, since that loan will cost the least amount of money to borrow.
5. Formally apply through the lender. Once you’ve decided on a lender, formally apply for the loan on their website. The lender will conduct a hard credit inquiry, which will affect your credit score.

How payday loans work

Payday loans offer a fast way to get a small amount of cash without a credit check, but they’re expensive to borrow. Here’s how they work: A payday lender issues a small loan to be repaid using the borrower’s next paycheck for a typical fee of between $10 and $30 per $100 borrowed. The borrower either writes a post-dated check or gives the lender permission to withdraw the loan amount, plus fees, from their bank account on their next payday.

While some borrowers may be able to pay the full amount back within a few weeks, many borrowers have to “roll over” their payday loans into a new loan, incurring a new finance fee and increasing the cost of borrowing.

See how the cost of borrowing and rolling over a payday loan can add up in the table below:

Benefits of a payday loan

Payday loans don’t often require a credit check. Payday loans are guaranteed by the borrower’s next paycheck, so they don’t typically require a credit check. This makes them an alluring option for borrowers with bad credit or no credit.

Payday loans offer fast funding. When you take out a payday loan, you may have access to the funding you need as soon as you apply.

Payday loans can be used to pay for virtually anything. If you need money in a pinch to pay bills, then payday loans may seem like a convenient way to make ends meet.

Why can payday loans be dangerous?

Payday loan interest rates are high. Borrowing fees typically range from $10 to $30 per $100 borrowed every two weeks. If you roll over your payday loan enough times, you could end up paying around 400% APR.

Payday loans have very short terms. Payday loans must be repaid by the borrower’s next paycheck, which is typically about two weeks. Some borrowers may be unable to come up with the full loan amount plus fees in that time period.

Consumers can get trapped in a payday loan cycle of debt. If a payday loan borrower can’t repay their loan, they may be forced to take out another payday loan to cover the original balance. This essentially doubles the cost of borrowing, just for rolling over the loan once.

What happens if you don’t pay a payday loan?

Payday lenders automatically withdraw the amount owed from your bank account on the due date. But if the check bounces or your account comes up short, the payday lender still has legal grounds to collect the debt they’re owed. The lender can report your delinquency to the credit bureaus, send your debt to collections and even take you to court over the debt.

How to get out of the payday loan cycle

Getting into a payday loan is as simple as handing over your financial information, but getting out of a payday loan isn’t so easy. Because they have such short repayment periods, the cycle of payday loan debt can be difficult to escape.

If you’re struggling to keep up with multiple high-interest payday loans, consider payday loan consolidation. This involves taking out a loan to repay multiple payday loans. For example, you could take out a personal loan or a 401(k) loan to pay off your payday loan debt and repay it in fixed monthly payments.

Borrowers who want to consolidate payday loan debt but can’t qualify for a traditional loan could also consider entering a debt management plan through a credit counseling agency.

Alternatives to taking out a payday loan

It’s hard to borrow money when you have no credit or bad credit, which is why payday lenders may seem like the only option for many low-credit borrowers. But if you need a personal loan with bad credit, a payday loan isn’t your only option.

Consider these alternatives:

• Use a paycheck advance app. Paycheck advance apps let you borrow from your next paycheck, often without fees or interest. For example, Earnin lets you borrow up to $100 per day — the money is withdrawn from your account, and you have the option to add a tip.
• Take out a secured loan. Secured personal loans are backed by collateral, which makes them less risky for the lender. If you own an asset like a house or car, you may consider taking out a secured loan — just make sure you can repay it to avoid repossession.
• Find a payday alternative loan (PAL). PALs are small loans offered through a credit union. They’re worth up to $2,000 and have a max APR of 28%. PALs offer an alternative to high-cost payday loans, though not all credit unions offer them.
• Talk to a credit counselor. Nonprofit credit counseling agencies can help with budgeting, financial counseling and debt management. These services often come at a low cost (or even no cost) to the consumer.
• Borrow from friends or family. This option isn’t available to everyone, but it could be a much better alternative compared with going to a payday lender. If you decide to go this route, approach the subject with honesty and transparency.