Having debts is unavoidable. At least once in your lifetime, you might have incurred debt and have had to deal with repayments.
Loans and debts aren’t entirely harmful to your finances, but not paying them back is. And before asking yourself “can I get a loan now”, you must know that if you borrow a significant amount you have to pay it back according to the agreement, and you must be sure you can do this.
Before borrowing money from any financial institution, a responsible borrower should know what type of loan program to take. Lenders may educate borrowers regarding these loans before having them sign up for one. Still, it’s advantageous on your part to recognize how these loans differ and which one is suitable to your needs, repayment capability, and financial situation.
Payday Loans Vs. Personal Loans: What Are They and How Do They Work?
Personal and payday loans are two of the most popular types of loans. These two work opposite each other when it comes to the different factors of the financial agreement. Before diving into the world of loans and debts, it’s crucial to learn about payday and personal loans first, as these two loans can provide the quickest access to cash.
Payday loans are small, short-term, high-cost loans meant to be paid back on your next pay check. There’s no question that payday loans allow fast approval without the need for an excellent credit history, but many financial experts advise against taking up payday loans
because of their high interest.
Meanwhile, personal loans are either secured or unsecured loans. Personal loans are acquired to finance different purposes ranging from major purchases to debt consolidation. Unsecured personal loans tend to have high interests and rely on credit rating, while secured personal loans can put your assets at risk. Stay tuned for a further discussion between these two later.
Both payday and personal loans can be identified as unsecured loans as they don’t require any collateral in the agreement—a reason many Canadians use unsecured loans. However, these loans are implemented with high interest to compensate for the absence of collateral.
How Do Payday and Personal Loans Differ?
Immediate approval and payment are the most significant similarities between payday and personal loans, but they’re considerably different concerning the following factors:
1. Loan Term
Upon taking out a loan, your lender will assign you with a regular repayment schedule spread across your entire loan term. The repayment length dictates the time it’ll take your loan to be completely paid off, given that your payments are up-to-date.
Payday loans have shorter loan terms compared to personal loans. As the name suggests, a payday loan is usually settled on the borrower’s next pay check because only a smaller principal amount is lent. Typically, borrowers should pay off payday loans two to four weeks after the initial loan date, but this can still vary from lender to lender.
On the other hand, personal loans are repaid within one to five years as agreed upon by the lender and borrower. Since personal loans are usually taken out for big spending, the monthly repayments are distributed into a longer loan term to make them possible and easier to pay off.
2. Principal Loan Amount and Interest Costs
The amount of your single repayments will depend on how much you borrowed, which is called the principal amount, plus the interest costs spread throughout the loan term. As a rule of thumb, the higher the principal loan amount, the higher the monthly repayments.
Lenders carry out interest to serve as their profit by putting their money on the line.
Most states and cities have a payday lending cap depending on the borrower’s personal circumstances. The lender will either approve or modify your desired principal amount depending on your expenses, income, and payday lending history. For example, in terms of interest, the borrower who takes out a loan for 30 days will need to pay more than GBP£24 in fees and other charges per GBP£100 borrowed.
Personal loans have a relatively higher principal amount spread out on longer predetermined repayment periods. Borrowers can obtain GBP£1,000 to GBP£10,000, which explains the use for huge purchases that we’ll tackle later. For instance, most lenders estimate that the average annual percentage rate (APR) of personal loans ranges from 2.8% to 10% in a 24-month personal loan.
Lenders may implement different interest rates depending on their calculation methods, including simple, compound, or add-on interest calculations. Make sure to clarify this with your lender before borrowing.
3. Eligibility Conditions and Requirements
You can’t simply enter into a lending institution expecting you’ll exit with a full pocket, especially if you don’t have an established financial reputation. Before taking out any loan, lenders will set conditions and requirements to determine if you’re eligible for the loan and its agreements. These requirements primarily involve your financial conditions like creditworthiness.
In payday and unsecured personal loans, lenders will solely analyse your creditworthiness by looking at your credit rating. On the other hand, secured personal loans require putting up collateral if the borrower fails to repay the loan. Using collateral, you can score larger principal amounts, friendlier terms, and more favourable interest rates.
Both payday and personal loans implement these minimum requirements:
- Indicated purpose of loan
- Personal and banking information
- Financial statements
- Cash flow
- The borrower must be in legal age
- Business plan, if the loan is intended to finance borrower’s venture
4. Typical Uses and Purpose
Payday loans seem to be more preferrable to people living from pay check to pay check.
Borrowers with this type of loan usually spend their borrowed payday loan money for daily living as they can’t stretch their previous pay check further. They may also use payday loans for unforeseen emergencies.
Contrarily, you can spend personal loans more responsibly through the following:
- Debt consolidation, or using the personal loan to pay off a high-interest debt
- Home improvements and renovations
- Emergency expenses
- Moving costs
- Travel and vacation expenses
- Wedding preparation expenses
- Alternative to payday loan
People also use these when investing in property, such as Disney Vacation Clubs. They click for DVC buyer financing and assess which loan to be applied for. Obviously, secured personal loans seem more suitable in such cases.
Bottom Line
Money is a primary necessity that can further fund your needs and wants in life. Financial education taught us to secure an emergency fund to avoid being financially off-guard. However, some people may not have the opportunity to build theirs yet, or have already spent them recently. This is where loans come into the critical picture.
It’s okay to take out loans occasionally as they can help build your credit rating. However, it takes a financially responsible individual to manage loans like the payday and personal loans discussed in this article. Avoid spiralling into a debt hole so you can start your journey to financial freedom without having to worry about loans, interest rates, penalty fees, and the like.
