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Buy now, pay later (BNPL) plans make it easy to split up a purchase into several installments with no interest. Find out how you really pay for BNPL.
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If you’re short on cash this holiday season, you may be tempted to use a buy now, pay later plan. These plans let you split a purchase up into four interest-free installment payments that you typically make biweekly. Most buy now, pay later plans don’t require a credit check.
But here’s the dark side of buy now, pay later (BNPL) plans: Retailers love these plans because they know you’re likely to spend more.
The truth about buy now, pay later plans
When you use a buy now, pay later service like Klarna or Afterpay, you’re technically getting an installment loan. But instead of making money off the interest you pay — which is what happens with a traditional loan — BNPL lenders earn the bulk of their payments from merchant fees. Shopify reports that these fees typically range from 2% to 8% of overall transaction costs.
Retailers are happy to foot the bill because they know that customers spend more when they use BNPL. One study found that 70% of customers admitted to spending more when they paid with buy now, pay later. Research also shows that BNPL makes you more likely to make a purchase you’re on the fence about. When you do make a purchase, the amount you spend is often higher.
In a paper called “Buy Now, Pay (Pain) Later,” researchers from the University of Washington, University of California-Irvine, and Singapore Management University, offer several explanations for why overspending is so prevalent with buy now, pay later plans:
Easy access to credit is generally associated with people spending more.BNPL lenders are more willing to extend credit to risky borrowers because they earn commissions from retailers.Since BNPL services rarely report to credit bureaus, customers can often borrow more than they can afford.
The same research found that customer usage of BNPL services is associated with an increase in overdraft fees, credit card interest rates, and late fees.
That finding is especially alarming because customers with shaky finances are more likely to use BNPL. The New York Survey of Consumer Expectations Credit Access Survey found that 43% of BNPL customers have credit scores of 620 or lower, while 37% reported being at least 30 days delinquent on a bill at some point in the last year.
Using buy now, pay later can be especially appealing to customers with bad credit because you can typically get approved without a hard inquiry to your credit report. But keep in mind that these plans won’t help you build credit. Whether you’re building credit from scratch or trying to improve a bad score, you’ll need a credit card or loan that reports your payments to the credit bureaus.
While BNPL providers won’t report your on-time payments to the bureaus, some do report missed payments. This means that BNPL is unlikely to help your credit score, but it could hurt your credit score.
When using buy now, pay later makes sense
Buy now, pay later comes with real risks, but it’s possible to use these plans without getting buried in debt or hit with fees. If you’re going to use a BNPL service, follow these tips to avoid risking your personal finances:
Only use BNPL for purchases you already planned to make.Make sure you understand when each payment is due and that you’ll have sufficient cash in your bank account to cover the payment.Read the details of the payment plan so you’re clear on whether you’ll be charged interest, what happens if you’re late on a payment, and whether the service reports to the credit bureaus.
Finally, consider the alternatives. If you’re eligible for a 0% APR credit card, this is often a better option than BNPL. You’ll get the zero-interest perk that many BNPLs offer, plus you’ll face fewer headaches if you need to make a return or dispute a charge.
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