Personal Loans vs. Payday Loans vs. Credit Cards - Which Is the Best for You?
There will likely come a time in your life when you find
yourself in a pinch and in need of fast cash. At this point, you may consider
taking out a loan. However, before you do know that not all forms of borrowing
are created equal. Everything from the APR to the terms of the loan to the life
of a loan can affect your ability to repay the loan, your credit score and your
future financial wellbeing. To find the best option for you, read on to learn
the differences between personal loans, payday loans and credit cards — the
three most common forms of borrowing in Canada.
Personal Loans
Personal loans are short-term loans that come with fixed
payments and fixed repayment periods. Like with credit cards, lenders make an
inquiry into your credit report when you apply, which could result in a slight
hit to your score. Also, like with credit cards, the interest rate that comes
with the loan ultimately depends on your credit score and repayment history.
Unlike credit cards, however, personal loans do not offer a revolving form of
credit. Once you repay the loan, the lender closes your account and you must
reapply if you need future financial assistance.
Lenders offer two main types of personal loans: secured and
unsecured. If you opt for a secured loan, you would need to put up some form of
collateral, such as your bank account or a CD. In exchange, the lender would
reduce your annual percentage rate. With an unsecured loan, on the other hand,
the lender assumes a majority of the risk in exchange for a higher APR. In
addition to interest, many lenders charge fees that can increase the total
lifetime cost of the loan.
You can use a personal loan for a variety of reasons,
including but not limited to buying a vehicle or house, making improvements to
your home or car, consolidating credit card debt and paying off unexpected
medical expenses.
Payday Loans
Payday loans are very short-term, high-cost loans that give
cash-strapped individuals the money they need to cover expenses until their
next payday (hence the name). Payday loans are not meant to cover huge costs,
and the typical amount is $500. You could use a payday loan to cover your
heating or electric bill until you receive your next paycheck or to pay for
unexpected, low-cost vehicle repairs.
Before offering a payday loan, the lender will inquire as to
your job status and sources of income. You may also have to grant the lender
access to your bank account or submit a post-dated check to cover the amount of
the loan.
Payday loans are costly. To borrow money, you must agree to
pay a finance charge, which ranges from $10 to $30 for every $100 you borrow.
According to the math, that equates to an annual percentage rate of almost
400%. If you fail to repay the loan within the two-week term, the lender is
likely to slam you with fines and additional fees.
Payday loans are only ideal if you are strapped for cash and
know you have the money coming to repay the loan within the next couple of
weeks. However, because they come with high fees and finance charges, you
should only use them as a last resort option.
Credit Cards
Credit cards fall into an entirely different category of
borrowing. Credit cards offer borrowers "revolving credit,” or credit they can
continue to access so long as they pay down the balance. Like with personal
loan lenders, creditors check your credit score to determine your
creditworthiness and to calculate your available balance and interest rates.
Credit card interest rates are typically higher than those associated with
personal loans.
Revolving credit works differently than the short-term
credit of personal or payday loans. Whereas with the latter two types of loans
you would receive one lump sum upfront and pay interest on the total loan, with
a credit card, you can choose to access funds from your account at your
discretion. You would only pay interest on the funds you use. If you don’t have
a balance at the end of the month, you don’t have to pay interest.
While credit cards are a great way to build your credit and
offer a readily available source of emergency funds, you need to be wary of
introductory rates, annual and monthly fees and late charges. Some credit cards
offer 0% introductory rates and then increase them to 30% after six months.
Others charge as much as $90 annual fees, while others charge $12 monthly fees.
Late fees range from as little as $3 to as much as $39. Regardless of the
terms, the rule of thumb when using credit cards is to pay down the balance in
full each month to avoid racking up debt in interest and fees alone.
Each type of loan serves its purpose. If you need fast cash or simply want available credit for a rainy day, talk to a reputable lender about which option is right for you and your situation.