Trying to decide between using a credit card or a payday loan? Let’s take a look at your options and considerations.
Whether you’re planning on buying a big-ticket item or are experiencing tight cash flow and want a way to pay your bills on time, a credit card or payday loan are both ways to get access to additional funds. Here we’ve unpacked these two options, weighed up how they work and pointed out some of the pros and cons of each to help you determine which one is right for you.
How do credit cards and payday loans work?
Credit cards are issued by banks or financial institutions and provide you with convenient, ongoing access to credit. Credit cards can be used to make purchases in most stores, over the phone or online. However, these cards come with fees. For example, when you use a credit card, you’ll be charged interest on your balance each month. In addition to interest rates, some cards come with annual fees and balance transfer fees. Credit cards also come with credit limits, which controls how much money you can charge to your card.
Payday loans are also known as short-term loans, cash advance loans or bad credit loans, and refer to small, short-term, unsecured loans that come at a very high interest rate – some as high as 300% p.a. An unsecured loan is one where the lender can take legal action against you if you fail to repay it. Like its name suggests, a payday loan is a loan you might want to take out for the short-term until your next payday, after which you’d be required to repay the loan.
The differences between credit cards and payday loans
|Feature||Credit card||Payday loans|
|Fees||Annual fees vary, but can sit between $0 and $1,200||20% establishment fee + 4% monthly fee for loans up to $2,000;|
Up to 48% annually + establishment fee for loans between $2,001 and $5,000
(terms between 16 days and two years)
Up to 48% annually for loans above $5,000 (terms longer than 2 years)
|Interest||Approximately 19-22% p.a. (but some cards offer 0% promotions)||Interest is charged in the form of establishment and monthly fees.|
|Repayment terms||Ongoing line of credit as long as minimum monthly repayments are made||Vary between 14 days and 12 months|
|Eligibility||Need to be employed, self-employed or retired with a suitable income and have good credit history||Flexible criteria; people with bad credit history, Centrelink payees, and unemployed can also be approved|
Weighing up your options
Pros and cons of using a credit card
- Ease of payment. Credit cards are widely accepted worldwide these days, and you can use them to pay for nearly everything online, over the phone or in store with a mere tap or swipe.
- Flexible repayments. As long as you keep up with your minimum monthly repayments, you can pay off a credit card debt at your convenience. However, note that you will be accruing interest as time goes by.
- Rewards. Most credit cards allow you to earn points you can redeem for various items as part of their rewards programs, or through affiliated frequent flyer programs.
- Longer application process. Compared to payday loans, getting a credit card is a longer and harder process. Even with so-called instant approval credit cards, it can take up to two weeks before you can use your card.
- Interest fees. Depending on your card’s interest rate, and the amount of time you take to repay the amount in full, you could end up paying more interest on a credit card than you would with a payday loan.
- Overall cost. After factoring in other charges such as annual and account fees, the overall cost of using a credit card could outweigh its possible benefits, so you should make careful calculations before deciding if this option will suit your budget and needs.
Pros and cons of getting a payday loan
- Easy eligibility. Most payday loans have lower criteria for approval than credit cards. This includes income, age and residency requirements, as well as credit history and employment factors. You can even sidestep the whole credit check process with no credit check payday loans.
- Quick approval and cash release. With payday loans, you will usually receive an answer instantly or within five minutes and, if approved, you will receive the money within a day or two.
- Cash flexibility. Unlike a credit card, which can only be used to pay for purchases at merchants who accept MasterCard, Visa or American Express, a payday loan gives you freedom to spend the cash however and wherever you wish.
- Short terms. These loans require that you pay them back quickly, which can be bad if you’re in financial difficulty. On the other hand, a quick repayment period could leave you debt-free sooner.
- High fees. Although payday loan interest rates are government-mandated, they remain higher than typical personal loan rates. A payday loan may also charge late fees that can mount up if you are late making a repayment.
- Overall cost. In general, the excessive fees you pay for this service make it a financially inefficient way to get extra cash, unless poor credit prevents you from considering other options.
Credit Card Finder User | BenBen hasn’t paid his bills over the last few months and is now in need of a short-term loan to tide him over. He wants to borrow $2,000 but isn’t sure if he can repay the full amount anytime soon.
He finds out that if he takes a payday loan for 30 days, he will have to make three fortnightly payments of $827 to repay a total amount of $2,480. He also discovers that if he uses his credit card to pay off those bills, at its rate of 20% p.a., he can pay off the loan slowly over two years by paying only $100 each month. The total amount he would have paid at the end of the two years is $2,403. Ben decides to use his credit card so he can save $77 in interest fees and pay off the borrowed money at his leisure.
Unfortunately, over the next two years, Ben’s financial situation doesn’t improve. He ended up only making the monthly minimum repayment on this credit card account, which was $41 on the first month and slightly less for each subsequent month.
This was easier on his cash flow, and Ben was glad he only had to make a small payment every month. But by making only the monthly minimum repayments, Ben took 24 years and 9 months to clear the debt, and paid a grand total of $7,709 over the entire period. The interest payment on that loan turned out to be $5,709 – nearly 3 times the $2,000 principal amount.
What else should you consider?
If you’re still unsure if a credit card or personal loan is best for you, you can ask yourself the following questions:
How long will it take before I can pay the borrowed money back?
How much will I pay in terms of fees and interests?
How can I make payment for what I need?
How will this affect my credit report?
Do I have a third option?
Ultimately, the choice for using either a credit card or payday loan for short-term financing depends on your specific preferences and needs. Do your research and calculations before deciding, and whatever option you select, be responsible with your repayment schedule to avoid falling into a debt trap.