Black Friday: What you should know about Buy Now, Pay Later plans
As consumers prepare for their holiday shopping this year, some may be turning to buy-now, pay-later credit to fund gift purchases, particularly young and low-income consumers who may not have direct access to traditional credit.
However, financial experts warn buyers not to be aware of the hidden financial risks involved with these popular loans. If you’ve shopped online for clothing or furniture, sneakers, or concert tickets, you’ve probably seen the option at the checkout to break down the cost into smaller installments over time. Companies like Afterpay, Affirm, Klarna, and Paypal all offer this service, with Apple slated to launch later this year.
But as economic instability increases, so do defaults. A September report released by the Consumer Financial Protection Bureau (CFPB) reveals the consumer risks associated with buy now, pay later (BNPL) plans, a market that is largely unregulated and lacks many of the same protections that offer other forms of credit loans.
risk of overspending
“One of the biggest risks of using buy now, pay later over the holidays is overspending,” said Annie Millerbernd, personal loan expert at NerdWallet, in an email. “A recent NerdWallet study found that consumers who have used BNPL in the past year have done so an average of six times.”
According to experts, it can be difficult to keep track of multiple BNPL loans. Millerbernd recommends using BNPL on a single gift or with a retailer and then paying off that loan before taking another one.
And buyers who use BNPL loans typically spend 10% to 40% more when paying with those loans than they do with a credit card, according to a new study by researchers at Harvard Business School. Because the credits break up a purchase into smaller installments, buyers can be enticed into purchasing larger items.
Here’s what you should know about BNPL plans before agreeing to them.
How does buy now, pay later work?
Marked as “interest-free loans,” Buy Now, Pay Later services require you to download an app, link a bank account or debit or credit card, and sign up to pay in weekly or monthly installments. Some companies, like Klarna and Afterpay, perform soft credit checks that are not reported to credit bureaus before approving borrowers. Most are approved within minutes. Scheduled payments will then automatically be debited from your account or charged to your card.
The Services generally do not charge you more than you would have paid up front, which means technically no interest accrues as long as you make the payments on time.
However, if you pay late, a flat fee or a fee calculated as a percentage of the total amount owed may be charged. These can be as high as $34 plus interest. If you miss multiple payments, you may be banned from using the Service in the future, and the late payment could harm your credit score.
Are my purchases protected?
In the US, buy now, pay later services are not currently covered by the Truth in Lending Act, which governs credit cards and other types of loans (those that pay back in more than four installments).
This means you may have a harder time resolving disputes with merchants, returning items, or getting your money back in fraud cases. Businesses can provide protection, but they don’t have to.
Lauren Saunders, associate director at the National Consumer Law Center, advises borrowers to avoid linking a credit card to buy apps now and pay later whenever possible. If you do, you lose the protection you get from using the credit card, while also opening yourself up to any interest owed to the card company.
“Use the credit card directly and get that protection,” she said. “Otherwise it’s the worst of both worlds.”
What are the other risks?
Because there is no centralized reporting of “buy now, pay later” purchases, this debt does not necessarily appear on your credit profile with major credit rating agencies.
That means more companies may let you buy more items even if you can’t afford them, since lenders don’t know how much credit you have established with other companies.
Punctual payments are not reported to credit rating agencies, but missed payments are.
“Right now, buy now, pay later generally can’t help you build credit, but it can hurt,” Saunders said.
Elyse Hicks, a consumer policy adviser at Americans for Financial Reform, a progressive nonprofit, said people might not give enough thought to whether they can still afford payments down the road.
“Because of inflation, people might think, ‘I have to get what I need and pay for it later in these installments,'” she said. “But will you still be able to afford the things you can afford now in six months?”
Why are retailers offering BNPL loans?
Retailers accept the backend fees for “buy now, pay later” services as the products add to the shopping cart. When shoppers have the option to pay for purchases in installments, they are more likely to purchase more goods at once.
When Apple recently announced it would be developing its own Buy Now, Pay Later service, Josiah Herndon, 23, joked on Twitter about “paying for 6 carts of (things) I can’t afford with Apple.” , Klarna, Afterpay, PayPal Pay in 4, shop pay in 4, & confirm.”
US household debt increases 03:46
Herndon, who works in the insurance industry in Indianapolis, said he started using the services because it took a long time to get a credit card because he doesn’t have an extensive credit history due to his age. Since then he has used it to pay for high-quality clothing, shoes and other luxury goods. Herndon said he aligns payment schedules with his paychecks so he doesn’t miss payments, calling the option “very convenient.”
Who should buy now, pay later?
If you’re able to make all payments on time, buy now, pay later Loans are a relatively healthy, interest-free form of consumer credit.
“If (the loans) work as promised and people can avoid arrears and have no trouble managing their finances, they have a place,” said Saunders of the National Consumer Law Center.
However, if you want to improve your credit score and be able to make payments on time, a credit card is a better choice. Ditto if you want strong legal protections against fraud and clear, centralized reporting on loans.
If you’re unsure about making payments on time, consider whether the fees charged by Buy It Now Pay Later companies result in higher fees than the penalties and interest charged by a credit card company or other lender would.
How is economic instability affecting buy now, pay later?
As the cost of living rises, some shoppers have started breaking up payments for essentials, rather than just expensive items like electronics or designer clothing. A Morning Consult survey released this week found that 15% of Buy Now, Pay Later customers use the service for routine purchases like groceries and gas, raising alarms among financial advisers.
Hicks points to the rising number of late payments as a sign that “buy now, pay later” could already be contributing to unmanageable consumer debt. A July report by rating agency Fitch found that app arrears rose sharply in the 12 months ended March 31, up to 4.1% for Afterpay, while credit card arrears were relatively flat at 1.4% stayed.
“It will be interesting to see the increasing popularity of this technology across these different economic waves,” Hicks said. “The immediate impact is what is happening now.”
The Associated Press receives support from the Charles Schwab Foundation for educational and explanatory reporting to improve financial literacy. The independent foundation is separate from Charles Schwab and Co. Inc.