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An unsecured loan vs. a payday loan

Written by - Akshatha Sajumon

August 7, 2019 6 minutes

Unsecured loans and Payday loans are used to pay the expenses or purchases that you might not be able to afford. We all know that it’s sometimes hard to predict when a sudden need for cash will arise.
Unsecured loans and payday loans represent two different approaches to obtaining extra cash in terms of loan size, loan period, cost, and qualifications.

Unsecured loan

An unsecured loan is a loan that is not backed by collateral to guarantee the repayment. Unsecured loans are given on the creditworthiness of the person. The creditworthiness of the borrower is assessed based on the five C’s of credit: character, capacity, capital, collateral, and conditions. Examples of unsecured loans are credit card purchases, personal loans, and student loans.

So in the event, you do not pay back the loan, the bank cannot directly seize your assets.
The unsecured loan takes 24 hours to process; you need to provide documents such as pay stubs, bank accounts, tax returns, and so on. The bank will also evaluate your credit score, income, expenses, wealth, and other factors. Currently, the bank and other financial institutions charge 5% to 36% interest. Higher and lower rates are available depending on your credit score and financial history.

The Pros

  • Less Risky

Unlike secured loans, unsecured loans do not require collateral. Which means, your lender can’t take your property if you cannot repay the loan and your personal property isn’t at risk in the event of a default.

  • Simple

You can get an unsecured loan approved in less than 24 hours, which serves the purpose when you are in dire need of money. But what counts here is a good credit score and a stable source of income. If these two are in place, then unsecured loans can be your ideal option.

The Cons

  • Rate of interest

Unsecured loans have a higher rate of interest since they don’t have any collateral against your loan. The interest rate can be as high as 36%, and this depends on your CIBIL score, meaning your creditworthiness. This score indicates the bank if you are capable of repaying the debt. So remember to maintain a good credit score.

  • The loan amount

The loan amount is often small because of the risk involved. Since the institutions do not hold any collateral, lenders often sanction less amount of loan. Unsecured financing can be an excellent source for small cash injunctions, but you won’t be able to make a significant investment from an unsecured loan.

Payday loan

A payday loan is a type of short-term borrowing when the lender has to pay high-interest credit based on income and creditworthiness. These loans are high-interest rates for short term cash. The other name of the payday loan is cash advance loan or check advance loan. They are meant to help employed people bridge temporary cash shortages. Payday lenders evaluate a borrower’s employment, bank details, and income to set an initial credit limit, which can increase over time if the borrower maintains a good record to the lender.

To obtain a payday loan, you have to fill out an application that meets specific requirements. For example, the person should be a resident of India and needs to be at least 18 years old. The loan has been granted as per the circumstances of the borrower. The due date could be extended generally up to 30 days. The borrower is free to pay the loan before or after the due date. So never get this type of loan if you are not 100% sure that you can pay it back.

The Pros

  • Simple

Where traditional loans and credit cards take a long time to process, getting a payday loan is a faster process. You need not have to fill lengthy forms; instead, the application procedure is quick and simple because all the interactions or process involved takes place online. Hence you can forget the clumsy and time consuming method of booking an appointment with lenders.

  • Suitable

Most of the conventional loans come with conditions like for example a car loan can be spent only to buy a car, but a payday loan can be used to pay anything say even an electricity bill.

  • No Collateral

Some lenders require you to pledge collateral to avail the loan. But with payday loans, you do not require collateral. If you have a stable source of income. i.e., a permanent job, then you can get a payday loan.

  • No credit rating

People with a bad credit score struggle to get a loan. But with payday loans, you can avail it even with a bad credit rating. All that you need is consistent income, >18 years of age, PR in your state, and an active account, that’s it, your all set to get a payday loan.

The Cons

  • Expensive

The interest on payday loans can range between 300 and 900 percent. The enormous costs associated with payday loans makes it difficult for a borrower to get out of it. Remember that it is highly crucial to pay your debt by the date of maturation. In case you are unable to pay back the loan under the given short tenure, then you could be facing a high-interest rate that continues to increase.

  • Debt loop

Your debt is the companies profit. Yes, its true, most payday loan companies make money when borrowers cannot repay previous loans end up extending their loans. It adds an extra burden on the borrower. He/ she has to repay more fees on top of the original amount borrowed, thus could land up being a never-ending loop.

An unsecured loan is appropriate if you have good credit, need a sustained amount of money and can afford to repay the loan in monthly installments. A payday loan is costly but might be the only resource if you have poor or no credit history or need money in a hurry. Care must be taken to not allow a payday loan to snowball in size by continually renewing it. The odds are against a payday loan borrower, so try to avoid it at all costs, if possible.

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