How Personal Loans Work
To get a personal loan, you need to apply to a lender. This can be a bank, credit union, or online personal loan lender. Generally, you would first complete an application. The lender reviews it and decides whether to approve or deny it. If approved, you’ll be given the loan terms, which you can accept or reject. If you agree to them, the next step is finalizing your loan paperwork.
When that’s done, the lender will fund the loan, which means paying you the proceeds. Depending on the lender, these may arrive through a direct deposit into your bank account or by check. After the loan is funded, you can use the money as you see fit.
Personal loans may be secured or unsecured. A secured personal loan is one that requires some form of collateral as a condition of borrowing. For instance, you may secure a personal loan with cash assets, such as a savings account or certificate of deposit (CD), or with a physical asset, such as your car or boat. If you default on the loan, the lender could keep your collateral to satisfy the debt.
Personal loans can also be found online. Numerous lenders offer personal loans through their websites. You can apply electronically, get a decision in minutes, and, in some cases, get funding in as little as 24 to 48 hours after loan approval. Using a simple online personal loan calculator can help you determine what kind of payment amount and interest rate are the best fit for your budget.
Lenders can have different requirements when it comes to the credit score, income, and debt-to-income (DTI) ratio that are acceptable to be approved for a personal loan. This can help you narrow down the loans that may best fit your credit and financial profile.
Key Differences
There are several key differences between payday loans and personal loans when it comes to meeting emergency expenses:
- Cost: Payday loans generally have much higher rates of interest than personal loans and may hit you with hidden fees and charges.
- Accessibility: Payday loans can be easier to arrange, especially for people with limited credit history and other financial challenges. With some payday lenders, you can even get a loan without a bank account as long as you have a prepaid card account.9
- Impact on your credit score: Most payday lenders don’t report to the credit bureaus.10 This means that only personal loans show up on your credit report. If you take out a personal loan and make payments on time, your credit score will climb, which will help you qualify for better loans and interest rates in the future.
In almost every situation, a payday loan will be more expensive than a personal loan. If you need emergency money, the best thing to do is to apply for a personal loan to see if you qualify. Then, if you don’t qualify, you can look at other options. Even then, it can be better to spend money on your credit card, ask your employer for overtime, or borrow money from family and friends.
Although payday loans don’t impact your credit when you borrow, they may be sent to collections if you fail to repay the loan. At that time, they may lower your credit score due to delinquency.
Is a personal loan a better alternative to a payday loan?
In general, a personal loan will be cheaper than a payday loan. Lower-cost personal loans give a borrower more time to pay off a loan than a payday loan does, and most credit unions offer personal loans with APRs comparable to those of credit cards, which still charge lower rates than payday loans.
Are payday loans hard or easy to pay back?
Payday loans are sometimes harder to repay than a traditional loan because the lender did not verify your ability to repay before lending you money. Payday lenders don’t generally assess your debt-to-income (DTI) ratio or take your other debts into account before giving you a loan.11
Do payday loans help your credit?
They probably won’t. Payday loans generally aren’t reported to the three major national credit reporting companies, so they are unlikely to impact your credit scores. Unless, that is, you fail to pay the loan back on time and you are referred to a debt collection agency, which would hurt your credit score.10
The Bottom Line
Payday loans are almost always more expensive than personal loans when it comes to borrowing money and are riskier as well. If you are able to qualify for a personal loan, choosing this option will allow you to borrow more money, give you more time to pay it back, and charge you a lower interest rate. If you need some emergency money, you should first apply for a personal loan.