Loans are becoming increasingly accessible, user-friendly, and tailored to meet individual needs. They provide flexibility during times of unforeseen circumstances. Various types of loans are offered in the market, with personal loans being a popular choice due to their competitive interest rates. Unlike credit cards, personal loans have lower rates, longer repayment terms, and a straightforward application process.
Another type of loan available is the payday loan, which is a short-term, high-cost loan usually for a small amount, typically $500 or less, intended to be repaid with the borrower's next paycheck.
Instant personal loans and payday loans serve as short-term financial solutions designed to provide quick access to funds. However, these two types of loans vary significantly in terms of their intended use, loan amount, repayment terms, and eligibility requirements.
Payday loans may provide assistance during a financial crisis, yet their exorbitant fees and brief repayment periods can surpass any advantages. Opting for a personal loan provides the advantages of lower interest rates, customisable repayment schedules, and the opportunity to improve your financial well-being.
"Personal loans are versatile, ideal for home renovation, education, or consolidating debt, and are either secured or unsecured. Payday loans are meant for urgent expenses and are usually unsecured, based on income. If you have a stable income and good credit, personal loans are a more affordable option with better repayment terms. Payday loans are best used in emergencies, with caution about their high costs," said Swapnil Aggarwal, Director, VSRK Capital.
Personal loan vs payday loans
Unlike specific loans for education or home purchases, personal loans offer flexibility in how you use the funds. They require no collateral, setting them apart from secured loans against assets like mutual funds or gold. This makes personal loans suitable for various needs, whether it's covering wedding expenses or addressing urgent bills. On the other hand, obtaining payday loans is a straightforward process, as they are short-term unsecured loans.
Banks, NBFCs, and digital lenders provide personal loans for various purposes, while payday loans are short-term loans intended to cover emergency expenses until the next salary payment. Personal loans usually range from Rs 50,000 to Rs 25 lakhs, whereas payday loans are typically smaller, ranging from Rs 1,000 to Rs 1 lakh.
One notable difference between personal loans and payday loans is the interest rates. The interest rate on personal loans can vary based on the loan amount and the borrower's credit score.
On average, personal loans tend to have lower interest rates, typically ranging from 10-24 percent per annum. In contrast, payday loans usually carry higher interest rates, falling within the range of 36 percent to 60 percent.
The processing fee for a personal loan can range from 1–3% of the loan amount, whereas a payday loan often charges a fixed fee or a high percentage of the loan amount. Personal loan repayment is typically made through monthly EMIs over the selected tenure, while payday loan repayment is usually due on the next salary payment date.
"Personal loans typically offer larger amounts, ranging from thousands to lakhs, with longer repayment terms (months to years), and lower interest rates (10-20%) based on creditworthiness. Payday loans, on the other hand, provide smaller sums (usually under ₹50,000), have high interest rates (200-300% annually), and require short repayment periods (15-30 days). Personal loans usually involve a credit check, while payday loans may not, making them accessible to those with poor credit," Aggarwal added.
Many lending institutions, including banks and NBFCs, offer both payday loans and personal loans. While personal loans require the submission of various documents due to their higher borrowing limit and longer tenure, payday loans typically do not require extensive verification and have simpler documentation. A detailed background check is essential for sanctioning personal loans, whereas payday loans have a more streamlined process.
Payday loans vs credit cards
When comparing monthly interest rates, credit cards are generally more affordable than payday loans. However, it is crucial to practice strict financial discipline when borrowing money through a credit card. Failing to repay your balance on time can result in accumulating costs, as interest is added monthly and can escalate if payments are not made.
Unlike payday loans, which have limits on the amount you repay (never exceeding double the borrowed amount), credit card costs have no restrictions. This means that the debt you accumulate on a credit card can continue to grow until you hit your credit limit, potentially leading to even higher costs in the future. It is important to be mindful of your spending and repayment habits to avoid falling into a cycle of increasing debt on a credit card.