The “buy-now-pay-later” trend (BNPL) is rapidly becoming a preferred method of payment, but consumers should understand how these plans work to avoid some related pitfalls, such as negatively impacting their credit.
BNPL is marketed as an alternative to credit cards because they allow consumers to spread out purchase financing, but with no fees or interest charges. During the pandemic, with consumers conserving cash and seeking alternative methods of credit, the service exploded in popularity.
First, it’s important to understand how the service works. The model varies but BNPL companies typically allow shoppers to pay for purchases in installments over several weeks or months. Most providers offer no-interest payment plans if the buyer pays off the product within four installments or a fixed period. But the fine print varies, as does the amount for late fees.
There are Two Distinct Categories:
- Point-of-sale lenders (Affirm, PayPal Credit), which usually apply to larger purchases such as Casper mattresses or Pelotons, are repaid over longer periods, require credit checks, and charge buyers interest.
- Pay-in-four services (Klarna, Afterpay), which charge no interest, require a 25% deposit, and operate without credit checks or reporting to credit bureaus.
How to Help Avoid 3 Pitfalls with the BNPL Trend
1. Understand How Your Plan Works.
Check the terms of the loans on the lender’s website, which are typically laid out on a support or FAQ page, or call and ask. Look out for how late fees are imposed and what happens if you miss a payment. Double-check if late or missed payments are reported to a credit bureau, possibly negatively affecting your credit score. Make sure you are getting the rules for the specific type of loan you are using since some lenders provide more than one type of financing program. Affirm, for example, offers loans of varying lengths, and the terms and interest rates can vary by retailer and your credit profile.
2. Avoid the Temptation to Splurge.
One obvious risk with BNPL programs is that those seemingly affordable payments may tempt you to spend more. In a survey last year by Cardify.ai, nearly half of BNPL shoppers said they increased their spending between 10% to more than 40% when they use these plans compared with using a credit card. The best way to avoid this is to stay within your budget and understand your income.
3. Track Your Payments.
A study last year by Cornerstone Advisors, a banking consulting firm, found that over the past two years 43% of those who used BNPL services were late with a payment. Being late with a payment might make you subject to late fees. The best way to avoid these costs is to automate the entire process. Schedule regular payments through your bank account or card.
BNPL businesses offer a new take on ways to push the payments of purchases down the road. There are many advantages to paying later, but a major disadvantage is the out-of-sight, out-of-mind issue.
Monitoring your credit score daily is one way to be sure you’re avoiding the pitfalls of the BNPL purchase plan.