Taking out a loan can be a viable solution in financial emergencies. However, some products may worsen your distress as they come with high fees and penalties.
For instance, payday loans (aka cash advance loans) are no-check immediate credit products extended to paycheck earners. However, due to their predatory nature, they are strictly regulated since you may be paying more than you took out in no time!
For that reason, consumers should apply for a standard personal loan, with which they borrow a certain amount of money and agree to repay it in installments.
Keep on reading as we contrast these two products below!
Payday Loans vs Personal Loans: 10 Major Differences
Let’s delve into the nuances of payday and personal loans and see how they compare across different aspects so you can make the best decision possible, regardless of whether you are in a financial bind or planning for the future.
1. Loan Purpose
Both payday and personal loans offer financial aid, but in terms of the urgency of the monetary need, they are designed for different purposes.
Payday loans are useful for covering pressing short-term needs like unexpected bills or emergency expenses, which cannot wait for the next paycheck.
On the other hand, personal loans provide flexibility by allowing you to borrow large sums of money for various purposes, from debt consolidation to home improvement projects or planning a vacation, which you have more time to pay back.
2. Loan Amount
Payday loans offer a fast and convenient way to get your hands on small amounts of money in times of need (up to $1,500 according to the Canadian government).
If you need more than that, you will need a personal loan, which can provide anywhere between $100 to $50,000, with e generous repayment term of up to 60 months. The qualifying conditions will depend on your credit report and the lender’s policy.
Note: When facing a financial crisis, first exploit all your other options before taking out a loan, especially a payday one, such as asking for help from friends or family, cashing in your vacation days, delaying paying your bills, or getting a pay advance.
3. Interest Rates
Payday loans are incredibly costly and should only be used as a last resort.
While the advertised payday loan rates seem competitive, you must remember that they compound to ludicrous amounts ranging between 400% to 700% APR.
For example, the maximum cost of borrowing a $100 payday loan in Alberta is $15, so for a $100 two-week payday loan, you will have to return $115 within two weeks. However, if you fail to repay the loan within a year, you will owe $390 on top of the $100.
In contrast, personal loans come with extremely lower APRs, which typically range from 6% to 36%, depending on the exact type of bank loan you obtain.
Note: Think twice before applying for payday loans since they also include several hidden fees and penalties that you learn about when it’s too late!
4. Loan Terms
Payday loans offer short loan terms of one to four weeks, as they are designed to be repaid with your next paycheck, as the name suggests.
Personal loans, however, have much more favourable repayment schedules, ranging between 12 to 84 months on average. This extended window gives you plenty of time to repay the loan without worrying about any unexpected expenses.
5. Repayment Structure
While payday loans seem like a quick fix to an unexpected expense, they come with a strict repayment structure: you must repay everything you owe (principal, interest, and fees) in one lump sum within a very brief window, as explained above.
On the other hand, personal loans allow you to spread out the loan amount over an extended period, making it much easier to budget for your repayments.
6. Collateral Requirements
In general, payday loans are fast-tracked as they are unsecured, meaning lenders do not require any collateral as a condition for loan approval. Failure to pay back such a loan will most likely result in collection calls or even a lawsuit.
Conversely, most personal loans are secured and they are approved under the condition borrowers present collateral (car, savings, boat, or another valuable asset), which can be taken from them if they cannot pay off the loan.
Note: Some lenders also offer unsecured personal loans at higher interest rates.
7. Credit Check
One of the rare appeals of payday loans is that they are approved without passing a credit check, which is also the reason they are processed on the spot. The only requirements are proof of income, a bank account, and an address.
To be approved for a personal loan, however, personal loan lenders must verify your creditworthiness, i.e., your reliability to pay back the loan.
Therefore, despite the ease with which you can get payday loans, spending time and effort to get your finances in order and fix your credit always pays off. That way, you can access large loans and save a lot of money on interest and hidden fees.
8. Impact on Credit Score
As a general rule of thumb, payday lenders do not file reports with the country’s credit bureaus, even if you are falling behind on your payday loan.
That said, payday loans may appear on a consumer’s credit report if the lender decides to involve a collection agency in the event of an unpaid debt. In such circumstances, overdue payments on a payday loan with plunge your credit score.
Conversely, personal loan activity is always entered into your credit report, so you must be timely with your payments to avoid reducing your credit score.
9. Rollovers & Extensions
Payday loans may seem like the ideal solution in an emergency, but they may come with a dangerous, often missed caveat: extremely costly rollovers or extensions.
However, since allowing borrowers to extend payday loans by paying additional fees can quickly spiral out of control, provincial laws often restrict such options. Otherwise, these fees can add up quickly and create a cycle of extreme debt.
When it comes to personal loans, however, things work slightly differently. If you are at risk of being late with your loan payments, your lender will typically charge you late fees, take the collateral, sue you for debt, and report the incident to the credit bureaus.
Due to their risky nature, payday loans are heavily regulated in Canada.
For instance, the maximum cost of borrowing $100 in payday credit has been capped at $17, which most provinces having a top limit of $15 or even $14.
Moreover, the maximum penalty for a returned cheque has also been limited to $25 across most of Canada, and the cooling-off cancellation period is set at two business days. So, you better be quick in getting out of the loan if you change your mind.
Personal loans are similarly regulated by separate provincial or territorial regulators in the province or territory where the lender is situated.
To sum up, payday loans are a precarious choice and should be used only when you have no other choice and you are certain that you can pay them off completely with your next paycheck. Otherwise, your debt will just increase indefinitely. To meet every other financial goal and avoid financial ruin, just apply for standard personal loans.