Beware of These Hidden Risks In Popular Buy Now, Pay Later Plans
It sounds like one of those too-good-to-be true propositions: Buy an item online, shell out just a fraction of the price at checkout and pay the remainder in installments over time, typically at no extra cost. As online shopping has soared during the pandemic, the popularity of these new payment programs, known as buy now, pay later (BNPL) plans, has skyrocketed as well. Last year alone, Americans spent $20.8 billion through these services, with purchases overall up 230 percent since the start of 2020, according to a study by Accenture commissioned by Afterpay, one of the leading players in the field.
Traditionally offered just for online spending by financial tech companies like Affirm, Klarna and PayPay Credit in addition to Afterpay, the types of BNPL plans available and the companies that provide them has grown sharply. Now the plans have been extended to include some in-store purchases too, and credit-card issuers are getting into the act as well, offering their own versions of installment payment plans. In other words, they’re everywhere these days. While estimates of use range widely, the consensus suggests that between at least one-third to one-half of Americans have used an extended payment plan at least once and that roughly three-quarters of them are repeat customers.
The appeal is understandable: In addition to the typically free financing, the application process is easy, with barely any credit check involved, and approval is nearly instantaneous. But there are risks too, and they’re often not understood by consumers. They include late fees that can pile up, possible damage to credit scores, a lack of the traditional oversight that governs other types of loans, and some shoppers being lured into spending more than they can afford. Those risks were considered serious enough by the Consumer Financial Protection Bureau that the watchdog agency recently launched an inquiry into the business practices of the five leading BNPL providers. The three major credit bureaus also announced changes at the end of last year to better track usage of these programs.
Thinking about taking advantage of the offer to extend payments—for free!—on your next online purchase? Here’s what you need to know before you click yes.
How the Plans Work
Buy now, pay later programs fall into one of two broad categories, usually depending on the price of what you’re purchasing. For items that cost $1,500 or less, the plan typically splits repayment into four equal installments spread across six weeks; you won’t be charged interest and the loan won’t impact your credit record or score. For larger purchases, payments are usually spread over a longer period, up to 48 months, and you’ll probably be charged interest that can run as high as 30 percent, depending on your personal profile and credit history.
The same companies often offer both plan types and the process is the same. You apply at checkout for credit that covers the amount of your purchase (versus, say, a larger line of credit on a standard credit card). You answer a few basic questions about yourself, such as your date of birth, email address and phone number, provide a debit or credit card number, and then, voila, you’re approved (larger loans might require a credit check). You pay a portion of the bill when you buy and the remaining balance in equal installments over a fixed period. If it’s a bigger-ticket item and the plan charges interest, that additional cost will be baked into each payment and spelled out before you accept the loan.
“It is a fast, painless process. You enter as little as four pieces of information about yourself and within 30 seconds find out if you’re approved,” says Ginger Schmeltzer, strategic advisor for Aite-Novarica Group’s retail banking and payments practice.
Prefer in-store shopping to digital deals? Not a problem. Some services now offer a similar extended payment plan via debit cards or digital cards you can access through their apps. Amex, Chase and other traditional credit card issuers have begun offering cardholders the option of a similar installment plan for some large purchases, typically for a fixed fee—likely to ward off the competition since more than half of BNPL plan users prefer them to credit cards and 38 percent say they intend to replace their plastic with them, C+R Research reports.
Part of the plans’ appeal is the fact that consumers see them as a more transparent form of borrowing than paying by credit card, with a fixed amount due each payment period and a deadline for settling the debt, which makes it easier to budget, says Matt Schulz, chief credit analyst at LendingTree. Shoppers with thin or poor credit histories or maxed-out cards also prefer these services because they have a better chance of approval. According to CB Insights, for instance, Affirm approves 20 percent more customers on average than comparable competitors.
The ease of the buy now, pay later process quickly makes converts out of its users. Almost half say they now choose this financing method most of the time or every time they shop online, according to C+R Research.
Consumers Are Confused
And therein lies part of the problem. Buy now, pay later plans make it so easy to finance a purchase that many shoppers sign up without really knowing what they’re getting into—one reason that the federal government consumer watchdog agency is looking into them. “The Bureau is aware of consumer demand for buy now, pay later credit and its substantial growth over 2020 and 2021,” the CFPB tells Newsweek. “This growth, combined with concerns about potential consumer misunderstanding of the products, and the lack of quality publicly available data on the BNPL market, led the Bureau to issue its market monitoring inquiry.”
Among the misconceptions: Many consumers don’t realize BNPL plans are a form of credit or a loan. Instead, people describe them as a “way to pay” or a “money management tool,” and a quarter of users incorrectly told The Motley Fool BNPL plans aren’t debt.
Since these services are relatively new and each BNPL provider has its own unique repayment terms and schedule, consumers can get mixed up. Nearly a third of users told LendingTree they didn’t know what the interest rate and fees would be before financing a purchase with one of the services. And only about a third told The Motley Fool they understand BNPL very well.
“People don’t always know what the financial risks are,” says Kathleen Blum, vice president of shopper insights for C+R Research. “They aren’t paying attention to the fine print terms because they don’t think they’ll ever need to or because they don’t plan on missing a repayment.”
The simplicity of the application and approval process, though, makes it easy for consumers to get in over their heads. Since many of the services do not check your credit file, there are few safeguards when it comes to whether you can truly afford to repay the loan, given other bills and debts you have to pay.
“Whereas the old-style layaway installment loans were typically used for the occasional big purchase, people can quickly become regular users of BNPL for everyday discretionary buying,” the CFBP said in announcing its investigation. “If a consumer has multiple purchases on multiple schedules with multiple companies, it may be hard to keep track of when payments are scheduled.”
In fact, almost six in 10 BNPL users told C+R Research that they regretted a purchase because the item was too expensive. And a third say they’ve missed at least one payment, according to Credit Karma.
Fail to pay on time and many providers charge late fees. Klarna has a $7 fee per missed payment, while Zip takes $5 to $10, depending on your state. Even when borrowing with companies like Affirm and PayPal, which don’t have such fees, missing payments can still damage your credit score if they report the unpaid loan to debt collectors and credit bureaus and affect your ability to get another loan. Credit Karma found that 72 percent of people who paid late saw their credit scores drop.
While the majority of users pay back their loans on time, BNPL does push people to spend more, compared to other forms of payment. When a store offers a BNPL option, research from Aite-Novarica Group found, the average bill jumps 40 percent.
The reason is partly psychological. When transactions are broken down into four or more small payments as these services do, consumers trick themselves into thinking they’re spending less. You know the shoes cost $150, for example, but because the bill says $37.50, you rationalize that you only have to shell out that much for now.
“These plans delay the present cost of the items we’re buying. Future losses always seem less scary than current ones and we always think we’ll be better off tomorrow,” says Carrie Rattle, a financial therapist who specializes in overshopping. “They play on consumers’ overconfidence in the future and the feeling that we have the ability to control the situation
because the payment seems like a small amount.”
One key difference between credit cards and BNPL plans that does help curtail debt accumulation: When consumers fail to make a payment or repay in full, they cannot use the service again until they do so. That said, because many companies don’t do credit checks or share info with other lenders, consumers can simply turn to other BNPL companies for new credit and then have several of these loans outstanding simultaneously.
“When you’re using BNPL for smaller purchases and doing so a lot, it can become a danger,” says Blum.
Impact on Credit Scores
Now that BNPL plans have gone mainstream, credit bureaus want this loan information better reflected in credit reports and are actively working on bringing that about. Equifax, for instance, announced in December, that it would standardize a process for reporting these loans and begin adding such data to consumers’ credit files likely this spring. The other two major credit bureaus, Experian and TransUnion, have also said they will be adding more BNPL data to their credit reports.
Equifax claims this will help lenders better decide whether to open new lines of credit to customers, while also rewarding BNPL users for their good repayment history—a change that could boost people’s FICO credit score, on average, 13 points to 21 points.
“Right now your credit is not really impacted by BNPL plans, unless you miss a payment or your debt is sent to collections,” says Francis Creighton, president and CEO of the Consumer Data Industry Association. “We think this is problematic. If you do pay on time nothing is reported. You get none of the upsides of repaying and correctly using these loans.”
Credit scoring models, like those operated by FICO and VantageScore, will also need to adjust, given that the current formula penalizes consumers for having several new credit inquiries in a short span of time and rewards longer loan-terms.
“If you use BNPL services, you might have seven loans at any one time. To traditional credit reporting, this looks like seven new loan applications but really it is more akin to seven charges on a credit card,” says Creighton. “We need to make sure this is adjusted correctly so people using the product as designed don’t get dinged for doing everything right.”
How to Buy Wisely
Buy now, pay later plans can be a great financial tool to help you afford necessary, but higher-cost items, especially if you nab a zero percent interest rate offer. And with rules surrounding how credit bureaus treat these loans changing, they can also be a smart way to build your credit history with less risk in the near future.
Still, as with all forms of borrowing, it is important to make sure you know the full terms of the loan before agreeing and feel comfortable meeting the required payments in light of your other ongoing expenses, like rent, mortgage payments or student loan bills.
Because BNPL payments follow their own schedule that commences on the day of your purchase, set up automatic payments and agree to receive reminders about upcoming bills. That way you won’t have to keep track of multiple repayments. Just be sure you have enough in your account when these services take an automatic payment or you could be hit with a $35 overdraft fee from your bank.
If you’re struggling to make a payment, call the lender before the due date to discuss possible solutions. Some services may allow you a grace period of a couple of days to before assessing the late fee, give you the option to extend or change the payment date, or offer hardship programs, if you, say, lose your job or experience a natural disaster.
Finally, experts caution that if you plan to spend a lot, or might need to return items, swipe the credit card instead. Your plastic comes with stronger consumer protections than BNPL plans, when it comes to disputed charges and may offer purchase protection if items are damaged or stolen, according to the CFPB. Says the agency: “Returning merchandise bought with BNPL can sometimes be complicated.” And who these days needs complicated?