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How is a payday loan different from a personal loan?

How is a payday loan different from a personal loan?

If you can’t afford the payment when your next payday comes around, that’s when a lender might offer you a “rollover.” A rollover allows you to just pay the initial borrowing fee until your next paycheck, but you’ll still be on the hook for the original loan balance plus the fee for the rollover amount. Since many payday borrowers end up rolling their balances over because they are unable to cover the full amount when it’s due, these fees can rapidly pile up. This makes it difficult to get out of the payday loan debt cycle.

A payday loan and a personal loan have some similarities. Both are unsecured loans, which means that unlike a mortgage or auto loan, they are not backed by any form of collateral. However there are a few important differences that you’ll want to be aware of.

Borrowing terms

Personal loans typically have terms of at least a year and up to several years. A payday loan has a shorter term. It’s common for payday loans to need to be repaid in a matter of weeks. Usually the full payment – interest and fees included – will be due on your next payday.

Amounts

A payday loan is typically for a smaller amount – usually under $500. Personal loan borrowers typically seek much more cash. As of the first quarter of 2021, the average balance for a new personal loan was $5,213, according to TransUnion.

Payment

Personal loans are typically paid online monthly via direct deposit from a bank account. With a payday loan, if your check bounces or you can’t pay the full balance on the required payday, you may have to roll the loan over to the next payday, accruing more fees in the process.

Rates

There are a wide variety of personal loans, but most will have much lower interest rates than payday loans. Your interest rate will depend on the lender, the amount that you borrow and your credit score.

What if I have bad credit?

Many payday lenders do not rely on a credit check at all. They understand that most borrowers who are looking for payday loans typically do not have the best credit. Instead, lenders make up for the increased credit risk by charging higher interest rates and more fees.

If your payday lender doesn’t require a hard credit check and you’re able to pay back the full amount by the required date, a payday loan typically won’t negatively affect your credit. If your lender does require a hard credit check, you may notice that your credit score drops a few points.

However, if your check bounces or you can’t pay the full balance on the required payday, the amount could be sent to a collection agency, which has negative consequences for your credit.

Risks of a payday loan

Due to the high interest rates and hidden fees, payday loans have the potential to derail your financial health and your credit score. “Payday loans charge a high interest rate, but the biggest risk of payday loans is the fine print,” Zhou says.

The fine print can include change fees, mandatory subscription charges or early repayment fees, and these can all quickly add up.

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“The biggest danger of payday loans is when they turn from a short-term stopgap into a long-term drain on your finances,” Zhou says.

If you don’t have a plan to pay your payday loan off in full on the requested date, you’ll have to roll your loan over, meaning you’ll be responsible for the principal balance and additional fees and accrued interest. This is a vicious cycle that could land you in high-interest debt down the road.

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