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When you need to borrow money, there are several options available to you for taking out a loan.
Personal loans can be an affordable option, and it often makes sense to take on this type of debt. Payday loans, on the other hand, are almost always very expensive and should be avoided whenever possible.
The two main differences between personal loans and payday loans are the cost of borrowing and the repayment period.
Here’s why these differences matter.
1. Borrowing costs
Payday loans are significantly more expensive than personal loans in virtually all circumstances.
When you take out a payday loan, you typically pay an upfront fee that can range from $ 10 to $ 30 for every $ 100 you borrow. So if you borrow $ 100, you might owe $ 110 or $ 130 immediately after you take out the loan. It may not seem like much, but as the Bureau of Consumer Financial Protection explains, it actually equates to an effective annual percentage rate (APR) of 400% or more.
In contrast, personal loans often do not come with an upfront fee. And if you are charged an application or origination fee, it’s usually a very small percentage of the value of your loan. Instead of paying an upfront fee, you’ll pay interest over time as you borrow.
Personal loan rate can vary widely, but typically range between 10% and 28% depending on your financial credentials. In some cases it is possible to get a much better rate than this.
But, in general, the fees and the effective interest rate you will be charged on a personal loan will be much lower than what you will be charged by a payday lender.
2. Payment deadline
Another huge difference between personal loans and payday loans is the repayment term.
When you take out a personal loan, it’s common to have more than a year to make your payments. In some cases, you could be up to ten years or more depending on the amount borrowed and the lender you are working with. Since you are paying back your borrowed money over a long period of time, ideally every monthly payment should be affordable and you should be able to build the payments into your budget.
A payday loan, on the other hand, is expressly designed to be a short term loan. You will usually only have about two weeks to repay the entire amount borrowed, including any fees you owe. And this is a huge problem because it means that you will have to find a significant lump sum in a very short time.
Most people who take out payday loans do so because they have an immediate need for cash. Unfortunately, if you find yourself in a difficult financial situation that requires taking out a payday loan, your finances are unlikely to have improved significantly in the two week period you have to prepare for repayment.
The result is that many people cannot repay the full amount of their payday loan once they receive their paycheck. This results in more borrowing and more fees, which can lead to a debt spiral. This is where your future paycheck – instead of going to your Bank account – is always promised to a payday lender, who then prompts you to take out another payday loan to cover your expenses since your check is gone before you get it.
Because payday loans have serious drawbacks in terms of repayment time and cost compared to personal loans, always aim for a personal loan rather than a payday loan if you can. And be sure to read the fine print of any lender you work with and confirm that you know both the costs you’ll be paying for your loan as well as how much time you’ll have to get off debt.
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