Taking out a loan can be a helpful way to afford costs you may not otherwise be able to cover at the moment. You may want to borrow to cover medical expenses, home improvements, or possibly even a vacation.
The most common forms of loans for quick cash are payday loans and personal loans, though one is a far better option than the other.
- A payday loan is a high-cost, short-term unsecured loan that has a principal that is a portion of your next paycheck.
- A personal loan is a long-term unsecured loan with higher minimum loan amounts and lower interest rates.
- You can use the money from either pretty much however you want to; aside from that, they have few similarities.
Stefanie O’Connell Rodriguez, the host of Real Simple’s Money Confidential podcast and a personal finance expert with Discover, recommends steering clear of payday loans if at all possible.
“It’s an option of last resort, like truly avoid it at all costs,” O’Connell Rodriguez says. “If you’re weighing something like, ‘OK, do I use a payday loan or a credit card or a personal loan,’ understanding that the payday loan is the option of last resort might help make that decision a little bit easier.”
What is a payday loan?
Payday loans are often for small amounts of money, commonly $500 or less. They are designed for borrowers who are in a pinch – maybe you need cash to cover an unexpected medical bill or a damaged item. Payday loans provide immediate funds, come with extremely high interest rates, and are usually based on your income, not your credit history.
“Payday loans come at a price,” says Kendall Clayborne, a certified financial planner at SoFi. “They may have interest rates of more than 600%. Such high-interest rates, not to mention other associated fees, can quickly lead to situations where you end up getting behind on the loan and have to borrow more and more in order to pay it back.”
Payday loans are never a better option than personal loans. They come with extremely high interest rates and are often predatory in nature.
“If someone were to personally ask me, I would never, under any circumstance, recommend a payday loan,” says Annie Yang, strategic financial advisor at Real Estate Bees.
- Astronomical interest rates
- Significant fees
- Could trap yourself in a cycle of debt if you’re unable to repay the loan initially
- Could borrow outside your means
You can get a payday loan by walking into a brick and mortar lender or via an online lender. When you take out a payday loan, you’ll often agree to give the lender permission to withdraw funds from your bank after your check has been deposited. The lender might ask for a signed check so they get the funds shortly after your next paycheck.
What is a personal loan?
With a personal loan, you apply to take out a specific amount of money. The lender will show you available offers depending on financial factors such as your credit score, debt-to-income ratio, and ability to repay the loan. You can use a personal loan for a variety of reasons, including home improvement, medical bills, and vacation.
“Personal loans come with a credit check to qualify, but will give you a longer-term to pay them back,” Clayborne says. “Your repayment timeline may be less stressful – giving you flexibility to pay over the course of a few years rather than a few months. With a longer payment term, your personal loan may be more manageable than a payday loan.”
Personal loans are always a better option than payday loans, as they come with lower interest rates and the lending decision is based on your ability to repay.
- Credit check required
- Higher minimum loan limits mean you may borrow more than you need
Online lenders, banks, and credit unions will give you money that you repay over a fixed period, say one year or five years. Personal loans are almost always unsecured, which means they don’t require collateral – like a house or a car in the case of a mortgage or auto loan – to receive. Most personal loans have fixed interest click for more info rates that stay the same over the life of the loan.
If you find that neither a payday loan nor a personal loan are meeting your needs, you do have alternatives.
Whether you decide to take out a loan or not, O’Connell Rodriguez recommended you don’t judge yourself too harshly based on your financial circumstances.
“Have compassion for yourself,” O’Connell Rodriguez said. “Understand that where you are, if you are in an emergency, if you are in debt, if you are in a very bad financial situation, it doesn’t say anything about your identity, doesn’t say anything about what you’re capable of, or who you are. It doesn’t define your goodness or your worthiness.”