Personal Loans vs. Payday Loans: Which Is Best For You?

https://atlascredit.com/loan-formWhether you have to pay an unexpected visit to the ER or need some extra cash to fix a leaking roof, taking out a loan can help you gain access to funds when you need them. Personal and payday loans are popular options. While both provide easy access to cash with an obligation to repay within a specific period, they have several differences in terms of repayment terms, annual percentage rates, fees, and flexibility.

What Are Personal Loans and How Do They Work?

A personal loan is a type of installment loan you can obtain from a lender, such as a credit union, bank, or online lender, to use for a variety of expenses, such as vacations, debt consolidation, and car repairs. Direct lender personal loans are repayable in agreed-upon monthly installments, which include interest over an extended period of time, commonly referred to as the loan term.

Eligibility Criteria for Personal Loans

To secure a personal loan, you must meet the lender's eligibility criteria, which may include one or more of the following: 

• Positive credit score and history: Lenders check your credit score to assess your credit history and eligibility. A high credit score shows that you have the financial capacity to make installment payments on time and that you have a history of doing so from previous financial commitments.
• Low debt-to-income (DTI) ratio: When you apply for a personal loan, the lender may evaluate your existing debts against your current income to determine if you can afford more credit. Many lenders prefer DTI ratios of 36% or slightly higher. To increase your chances of getting your loan request approved, consider increasing your income or reducing your outstanding debts.
• Income: Lenders may require proof of income, like pay stubs or an employment letter, to show that you can pay back the loan.
• A co-signer: Some lenders may require a co-signer with high credit to improve your chances of getting the loan approved.

Types of Personal Loans

There are two types of personal loans — secured and unsecured loans. 

• Secured loan: This type of personal loan requires you to provide assets, such as real estate and cars, as collateral, reducing your credit risk. Applying for this type of loan with collateral improves your approval prospects while lowering your interest rates. 
• Unsecured loan: An unsecured loan doesn't allow you to pledge collateral, but is based solely on your credit record and ability to prove creditworthiness. Because the lender assumes a greater risk without collateral, interest rates may be higher than those of a secured loan. 

Pros and Cons of a Personal Loan

Personal loans have several pros and cons, and understanding them can help you decide if they're right for you.

Pros of a Personal Loan

Personal loans have several advantages, including: 

• Flexible borrowing limits: Personal loans are designed to allow you to borrow higher amounts of money.
• Swift funding: Personal loans typically feature a quick and straightforward application process.
• Reasonable interest rates: Although interest rates on personal loans vary from lender to lender, they're typically lower than those on other options, such as credit cards.
• Versatility: With personal loans, there are no restrictions on what you can use the borrowed funds for. You have complete discretion to use the money as you please.
• Predictability: Fixed rate structures are standard for most personal loans, meaning the interest repayable remains the same throughout the loan term. This stability makes it easier to budget monthly payments in advance. 
• Tailored repayment terms: Repayment periods typically range from 2 to 7 years, providing flexibility. You can customize your loan terms to match your income and the amount you can afford monthly.
• Credit-building potential: Repaying your personal loan on time can help build your credit score and diversify your credit mix.

Cons of a Personal Loan

Personal loans have some potential drawbacks:

• Potential extra fees: Interest may not be the only payment you make on a personal loan. Some lenders may also charge additional nonrefundable fees. For instance, you may be charged an origination fee for loan processing and early payoff fees if you pay off the loan earlier than agreed upon. 
• Temporary impact on credit score: A personal loan application may temporarily lower your credit score due to a hard inquiry, which the lender will conduct to assess your creditworthiness. The good news is that you can build your score back with prompt repayments in no time. 
• Stringent eligibility requirements: Some lenders may impose strict qualification requirements that you must meet to obtain the best rates. Without meeting these requirements, you may be denied access to the loans entirely. 
• Increased debt load: Personal loans can be beneficial for debt consolidation. While this is an advantage, it can lead to an over-reliance on credit, causing you to increase your debt load over time. 
• Credit damage: In the same way that personal loans can improve your credit score when you make prompt repayments, they can also damage your credit score if you default.

When Is a Personal Loan a Good Idea?

Weighing the pros and cons of a personal loan is a crucial step in deciding whether it's a good idea for you. Here are some situations where a personal loan may be a smart choice: 

• Your credit score is high: Having a high credit score increases your chances of securing better rates and higher loan amounts. 
• You have a steady income: A steady income ensures you can make monthly payments on time.
• You have essential expenses to make: While you have the flexibility to choose what you'll use the funds for, it's always advisable to use them for essential expenses. 
• You want to consolidate a high-interest debt: Personal loans are an excellent way to consolidate your credit card and other debts. 
• You don't have collateral to use: An unsecured personal loan gives you access to funds without a requirement for collateral. 
• You have a low debt-to-income ratio: With a low debt-to-income ratio, you stand a better chance of getting a personal loan approval. 

When a Personal Loan Might Not Be a Good Idea

It may not be ideal to get a personal loan in these cases: 

• You tend to overspend: If you tend to overspend, a personal loan could potentially increase your debt.
• You can't keep up with monthly payments: You should have a steady income to comfortably take out a personal loan. If you can't make monthly payments, a personal loan may strain your finances and isn't recommended.

How to Get a Personal Loan

You can apply for a personal loan in person through your bank or credit union. Alternatively, you can explore online personal loans. These are some necessary steps for preparing for and completing a personal loan application: 

1. Check your credit score and DTI ratio: Make sure you have a qualifying credit score and DTI ratio before applying for a personal loan.
2. Research lenders and their terms: Different lenders will have different terms and eligibility criteria. It's good practice to evaluate and compare the borrowing terms of each lender you're considering. 
3. Gather the necessary documentation: Compile the documents required to complete your personal loan application, such as bank statements, pay stubs, and tax returns. 
4. Apply for the loan: Fill out the application and wait for a decision. If approved, the lender will deposit the funds directly into your bank account. It's possible to take out a personal loan to refinance an existing debt, in which case you can apply to have the lender directly cover the expenses for which you're taking the loan.

What Are Payday Loans and How Do They Work?

A payday loan is a short-term, high-interest loan that allows you access to funds repayable by your next paycheck or within 10 to 14 days of obtaining it. Think of it as receiving an advance on your salary before the expected date. You can get this type of loan from a bank, credit union, or online lender. Each state has its own laws governing payday loans and the maximum fees and interest lenders can charge on them — in some states, they're not permitted under the law. 

Unlike with a personal loan, you don't need a high credit score to access a payday loan. Instead, all you need is a valid identification, a checking account and proof of income. You must also be at least 18 years old to qualify for this type of loan.

Payday Loan Amounts: How Much Can You Get? 

Payday loan amounts depend on your income and the lender. Typically, you can expect to receive $500 or less, though some lenders may offer more. Some states also specify the maximum amount allowable per loan.

Pros and Cons of Payday Loans

Payday loans are popular since they're easy to access. Like personal loans, they have several advantages and considerations.

Pros of a Payday Loan

The benefits of payday loans include the following: 

• Fast access to cash: With payday loans, you can access funds more quickly due to the speed of the application and approval process. In some cases, you can get the funds in your account within the same day as your application.
• Less stringent eligibility requirements: This type of loan is best for those with low credit or high DTI ratios because of the lack of strict qualification requirements. Lenders are less concerned with risk when offering small payday loans, so the approval parameters are lenient. 
• No collateral requirements: A payday loan doesn't require you to provide collateral to access funds. 

Cons of a Payday Loan

Payday loans aren't always as simple as they seem. They come with costs and drawbacks, including: 

• High interest rates and fees: While payday loans offer instant access to funds, they come with high interest rates that make them more expensive than other options. The fees for missing a payment are also high. 
• Short repayment times: Payday loans are typically required to be repaid within shorter periods, usually two to four weeks from the date they're taken out. This repayment structure can be challenging, especially if you're still dealing with financial constraints.
• Increased risk of debt cycles: Taking out payday loans can increase the risk of entering into debt cycles. For example, if you're unable to repay a payday loan when it's due, you may be tempted to take out another one, and the cycle continues. 
• Potential credit damage: Payday loans generally have no positive impact on your credit score because most lenders don't report prompt payments to credit bureaus. However, they can hurt your score if you fail to make timely repayments. 

When Is a Payday Loan an Ideal Option? 

A payday loan may be an ideal choice for certain circumstances: 

• Financial emergencies: If you're faced with a situation where you need urgent financial help, a payday loan may be an excellent option.
• Small loan amounts: Consider a payday loan if you only need small amounts of money that would otherwise be unavailable through other loan options.
• Low credit and high DTI ratio: Since the eligibility requirements for a payday loan aren't as strict as those for a personal loan, you can get access to funds even if you have a low credit score or a high DTI ratio. 

When Is a Payday Loan a Bad Idea?

Despite the speed of a payday loan, they're not always a good idea in every situation. These are some instances when a payday loan may not be the best choice for you: 

• Debt consolidation: Payday loans aren't ideal or recommended for debt consolidation. Using funds from these loans to pay off existing debt can worsen your financial situation.
• Complete paycheck reliance: If your current financial circumstances require you to live paycheck to paycheck, a payday loan may tighten your budget even more. 

How to Apply for a Payday Loan

The application process for a payday loan is usually quick, requiring the following steps: 

1. Fill out an application form: The first step is to complete and submit an application form online or in person. You'll need information such as your income and your employer's details.
2. Receive a decision: After the lender reviews your application and approves it, they'll contact you with a loan offer outlining the terms. If you agree to the terms and sign the agreement, funds will be deposited into your bank account. 

Payday Loans vs. Personal Loans: Main Differences

There are several differences between a personal loan and a payday loan. Ultimately, a personal loan is better for most borrowers than a payday loan, especially when you borrow from a lender willing to help you navigate financial hardship. While payday loans provide quick access to a modest amount of money, personal loans offer more money and more favorable terms.

Here are some distinctions between the options and the reasons you should choose a personal loan over a payday loan: 

• Repayment terms: Personal loans often offer much higher loan limits than your average payday loan. This is typically because personal loans can be paid off over several months, whereas payday loans are intended to be repaid as soon as possible.
• Interest rates: Payday loans are short-term loans with high interest rates. They're designed to bridge the gap between one payday and the next. That's why you must repay them by your next payday at most — if not, you could end up with a worse financial situation overall.
• Qualification flexibility: To obtain either a payday loan or a personal loan, you'll be required to fill out an application to see if you qualify. Both payday loans and personal loans are forgiving of individuals with low credit scores, but personal loans are more forgiving in the long run.
• Loan amount: Both payday loans and personal loans allow for varying loan amounts, though personal loans typically offer more money.

How to Find the Right Lender

Choosing the right lender is an important step in the loan process. Here's how to make an informed decision:

• Determine your needs: Before you start looking for a lender, figure out exactly how much money you need and what you'll use it for. This will help you narrow down your options and avoid borrowing more than necessary.
• Check your credit score: Your credit score plays a role in the interest rates and terms you'll be offered. Obtain a copy of your credit report from one of the major credit bureaus — Experian, Equifax, or TransUnion — and review it for any errors.
• Shop around and compare: Get quotes from multiple lenders, including banks, credit unions, and online lenders. Compare interest rates, fees, repayment terms, and eligibility requirements.
• Read reviews and check ratings: Look for online reviews and ratings to get an idea of lender reputations and customer service.
• Look for transparency: A reputable lender will be upfront about loan terms, including interest rates, fees, and repayment schedules. Be wary of lenders who aren't transparent or try to hide information.
• Beware of predatory lending practices: Watch out for lenders who offer loans with extremely high interest rates or require you to provide collateral for a personal loan. These could be signs of predatory lending. The Consumer Financial Protection Bureau can be a good place to start for educating yourself.
• Consider customer service: Choose a lender that offers excellent customer service and is responsive to your questions and concerns. You want to work with a lender who's willing to help you throughout the loan process.
• Read the fine print: Before signing any loan agreement, carefully read all the terms and conditions. Make sure you understand your obligations and the consequences of defaulting on the loan.

By following these steps, you can increase your chances of finding a reputable lender who offers a loan that meets your needs and fits your budget.

Why You Can Trust Us to Compare Loans

The financial decisions you make today impact your future stability. It's essential to do research and make informed choices. Atlas Credit is an institution you can trust when weighing your options. 

We've helped hundreds of customers understand the differences between borrowing options such as payday loans and personal loans. Every customer we serve has a unique set of circumstances, and we work hard to determine the ideal solution for each one. Our firsthand experience has shown us the benefits of choosing a personal loan. From the outcomes we've helped our customers achieve to the individual stories they've shared, it's clear to us that personal loans are a competitive option.

As a financial institution that keeps your best interests in mind, we're here to provide helpful insight. You can count on the information we share online and at dozens of neighborhood branches to lead you in the right direction.

Learn More With Atlas Credit

Ultimately, it's up to you to decide which loan option is the right choice. If you're leaning toward the benefits of a personal loan from a lender like Atlas Credit, consider applying online or at a location near you.

We can help you get the money you need. Contact Atlas Credit today to learn more about the personal loan process.