Payday Alternative Loans vs. Personal Loans: What's the Difference?
Christy Bieber, The Motley Fool
Updated
Payday alternative loans can get you cash fast. But are they really that different from personal loans?
Woman looking at financial paperwork with a calculator.
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Finding the right way to borrow money can be complicated, especially when you need fast access to cash or want a short-term loan. Some borrowers turn to payday loans to meet their needs for quick funding, but this is a very bad idea because payday loans have ridiculous fees and an effective annual percentage rate that’s often over 400%.
Fortunately, there’s a better alternative to payday loans: payday alternative loans (PALs) from credit unions. Payday alternative loans are different from traditional personal loans in important ways, and you need to know some of those key differences so you can decide whether a PAL is the best way to borrow or whether you’re better off with a more traditional personal loan.
What is a Payday alternative loan?
The National Credit Union Administration, which is the federal agency that regulates the nation’s credit unions, established guidelines to allow federal credit unions to offer payday alternative loans.
These loans must meet specific requirements. First, the loan terms must range between $200 and $1,000. Second, the loans have capped fees, as credit unions can’t charge more than $20. The loan repayment term also has to be between one and six months, and borrowers are limited to no more than three payday alternative loans during a six month period. Finally, no payday alternative loan can overlap another.
Because these are small-dollar, short-term loans, they are intended to replace costlier payday loans. But they differ in some important ways from traditional personal loans.
Availability and eligibility for loans
Payday alternative loans are designed to be fast and easy to qualify for. But, these loans are only offered through credit unions. That means you have to be a member of a credit union to get one.
There are lots of different ways to become a member of a credit union. You may be eligible based on military service, because you live in a specific area, or you work in a specific field. You may also be able to simply pay a fee or make a donation to become a member. But, you’ll have to find a credit union you can qualify for and join before you can get a PAL.
While credit unions also offer standard personal loans, often at competitive interest rates, you do not have to be a member of a credit union to be eligible to obtain a standard personal loan. In fact, there are many different lenders other than credit unions that offer personal loans including local banks, national banks, online lenders, and peer-to-peer lenders.
Loan repayment term
PALs are required to be repaid over a one to six month term. This is a much shorter repayment term than most personal loan lenders. Personal loans, unlike either payday loans or payday alternative loans, typically give you at least a year to repay what you’ve borrowed. And, in many cases, personal loans have repayment periods ranging from three to five years or longer.
A longer repayment timeline gives you the opportunity to borrow more money while still keeping payments affordable -- but it does mean you’ll be in debt for a longer period of time.
Loan amount
There’s also a big difference in the amount you can borrow when comparing PALs with traditional personal loans.
With payday alternative loans, you can borrow a minimum of $200 and a maximum of $1,000. With more traditional personal loan lenders, it’s often difficult to find lenders willing to make loans that small. Many lenders have minimum borrowing amounts of at least $1,000 and often as high as $5,000 or more.
It’s not just the minimum loan amount that is higher with traditional personal loan lenders -- the maximum you can borrow is also much higher. It’s common for personal loan lenders to allow you to borrow $40,000 or $50,000, and some have even higher maximum loan amounts of $100,000 or more.
Because you can borrow much more with a traditional personal loan, personal loans are a better choice for big purchases or if you need a large sum of money to consolidate existing debt. Payday alternative loans are preferred if you have a short-term need for a little bit of cash, such as to cover a shortfall until payday or a small unexpected expense.
Capped fees
Payday alternative loans also cap application processing fees at $20 maximum. Some personal loan lenders don’t charge any processing fees, application fees, or origination fees -- but others do. And, when personal loan lenders charge fees, they could be charged as a percentage of the total you borrow and could sometimes be much higher than $20.
When you take out a traditional loan from any personal loan lender, it’s especially important for you to read the fine print and understand total upfront and ongoing loan costs. While you should also check the fees on payday alternative loans, you’ll know that this cap protects you from excessive charges.
Are payday alternative loans right for you?
Payday alternative loans are designed for a very specific situation: When you need to borrow a small amount of money quickly, and you can repay back the money in a short time period. Personal loans aren’t ideal in this type of situation because it can take too long to get your money, can take too long to repay the funds, or would force you to borrow more than you need to cover your short-term financial shortfall.
Personal loans are much more versatile, because you have a wider choice of lenders and because you have more flexibility in the terms of your loan. You can borrow more, pay it back over a longer time, and have the opportunity to shop around with all different kinds of lenders and not just credit unions you have to be a member of.
You’ll need to carefully consider your goals for borrowing and look closely at the amount you need to borrow when you decide if a payday alternative loan or a traditional personal loan is the right choice for your situation.
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