Have you ever been in a financial situation where you desperately needed some money to tide you over an emergency? Whether it was an urgent home-related cost, a car breakdown or a business related situation, they come out of the blue and often need to be paid within a short time frame.
My experience was a positive one, but initially I was faced with choosing between a personal loan and a payday loan. While my more financially conservative father wanted me to choose a personal loan, my best friend suggested a more modern approach and wanted me to take out a payday loan. She advised me to do the research and choose the best payday loan provider though, just to be safe.
In the end, I choose a personal loan over a payday loan (let’s just agree that dads know best when it comes to money matters!). Whilst I’m not asking you to trust my recommendation, I conducted extensive research before making the decision. Here’s all the details so you don’t need to go looking like I did.
Understanding Personal Loan
Personal loans are unsecured loans offered by banks and other online lenders. Usually, no collateral is attached to such loans and you return the amount over a fixed period. Unlike car loans or housing loans, which is money that can only be used towards particular things, with personal loans you can use the money for anything. You can invest it, undertake home renovations or go on an international trip, (although this is probably not the most financially wise decision!).
Understanding Payday Loans
Payday loans are short-term loans that are meant to be paid back by the next payday. These are meant for immediate financial needs and the borrowed sum is usually much less than personal loans. Payday loans are characterised by high interest rates and convenience. You can use these quick loans to pay for smaller emergencies such as tending to a car breakdown, paying for some urgent repairs or covering the cost of utility bills if you have run out of money by the end of the month.
Personal Loan Vs Payday Loan
So, once I understood the concept of both these loans, I chalked up a pros and cons list to summarise. I will share the same with you so that it’s easier for you to navigate through:
| Personal Loan | Payday Loan |
| Interest rates are much lower than payday loans. | Payday lenders usually charge a high interest rate. A borrower can pay 0.8% interest per day or 1250% APR (FCA has capped this as the maximum limit). |
| You get to repay the loan over a longer period (1 to 7 years); usually, monthly instalments need to be paid until the total amount (initial amount + interest) is paid back. | You only have a few weeks to repay the loan. Failure to do so will lead to paying additional money. |
| The amount borrowed is much larger. | The amount borrowed is much smaller, anywhere between £100 to £1,000. (so more lenders can offer a higher amount) |
| A large amount of documentation is required. Credit checks are conducted to determine the creditworthiness of the borrower. | Less documentation is needed to get approved for payday loans. Many lenders also offer bad credit payday loans. |
| Personal loan approval takes a lot of time and verification. | Payday loans are usually approved within a day and the application process can be completed online. |
Why Did I Choose a Personal Loan Despite The Advantages of Payday Loans?
Payday loans can be extremely beneficial, especially for anyone with a bad credit history. However, the high interest rate and the shorter repayment period are what scared me. While I needed some extra money, I didn’t want to get into a vicious debt cycle which can be possible with payday loans.
If I was unable to pay it back on time, payday lenders could levy a hefty fine, further emptying my pocket. Plus, I wasn’t in a super desperate situation. I could easily wait a few weeks to receive approval for my loan. My credit score was pretty decent (705 on the Equifax scale), so I was confident of getting approved at a competitive rate and terms.
However, if you need money immediately, then payday loans are probably the better alternative.
One last thing that tipped the scale in favour of personal loans was the impact each loan could have on my credit score. Timely repayment of my personal loan could further enhance my credit history. Meanwhile, payday loans are not notified to credit rating agencies so it failed to have any benefit on my long-term financial goals. However, if I fail to return the loan amount, lenders not only levy charges but also notify debt collectors, which can negatively affect my creditworthiness.
Considering my current financial needs and the short-term and long-term impacts of this decision, I decided to take out a personal loan.
In Summary
Financial literacy and discussions with professionals and family members can be extremely beneficial when it comes to getting out of debt, or combatting unexpected payments. Every person and their situation and personal finance goals are different, thus, evaluating your choice based on individual circumstances can help you make the right decision.
I hope my research and account can help someone else make a decision between personal loans and payday loans.
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