Buy now, pay later schemes are a new way of spreading the cost of purchases at promotional interest rates. Nearly seven million Britons said they used the revolutionary payment method at least once over the last year. But around two million said buy now, pay later (unknowingly) damaged their credit score.
What is buy now, pay later?
Buy now, pay later (BNPL) is a form of credit at promotional interest rates. It allows you to split the cost of a product purchased online into smaller payments. Some BNPL providers let you spread the cost over eight weeks at zero interest rates. But if you fail to pay for that product in full after the deadline, hefty interest rates and late fees may kick in.
Buy now, pay later is marketed to younger shoppers, such as Millennials and Generation Z. BNPL provider Clearpay says that 60 per cent of ‘Gen Z’ people do not own a credit card. So, buy now, pay later is a nice alternative to traditional credit lines. It is also a handy way of allowing people to keep shopping even if they’ve reached their credit card limits.
The big winners of the scheme are retailers. The number of items in a shopping jumps 20-30 per cent when the user opts for BNPL. BNPL providers that offer zero interest rates make profit off retailers. For each £100, there’s usually a £4-£5 fee for the retailer.
The biggest players on the BNPL market in the U.K. are the Sweden-based Klarna, Laybuy and Clearpay. Many online retailers and fintechs, like Very and Paypal, offer an in-house BNPL service.
Buy now, pay later is so popular because it enables shoppers to purchase items before they sell out. It also allows them to buy big-ticket items without hurting their wallet. And it is a convenient form of credit for when there’s some time left before payday but no money in your wallet.
Younger shoppers use BNPL especially when shopping for clothes. With the scheme, they can try different sizes of the same piece at zero refund costs. Shoppers can also hit the retailers’ free delivery thresholds easier.
However, there are some serious downsides to buy now, pay later credit. There’s the debt issue. According to a Compare the Market survey, two in five shoppers said buy now, pay later enticed them to buy more. And more than half (51 per cent) said the payment method had increased their debt problems.
Besides, 39 per cent of the shoppers in the 25-34-year age cohort have dented their credit score through BNPL. Many of the respondents were not even originally aware that BNPL had dented their credit.
Because BNPL is so convenient (zero interest rates, quick approval), many young people fail to see it for what it is. It is a form of debt. PayPal market their BNPL service as a “credit card without the plastic.” So, it is enough to miss a few payments for real troubles to start. And it is not hard to skip payments. The payment method often makes people lose track of what they bought.
Missing payments is the most common way of hurting one’s credit score when using BNPL. But nearly half of users (40 per cent) said they weren’t aware of the risk. Plus, 20 per cent complained of the lack of transparency of the service’s terms and conditions.
Indeed, many BNPL providers fail to list the negatives in their marketing efforts especially for offers implying zero interest. If a form of credit carries zero interest, the FCA cannot regulate it.
Missed payments will leave an ugly mark on your credit report for six years. They will tell potential lenders that you may not be as creditworthy as you claim to be. A dented credit score can become a real roadblock in obtaining new credit, such as a mortgage.
But there are other ways to hurt your credit with buy now, pay later. Many BNPL providers run hard credit checks when you apply for one of their costlier financing options. For instance, Klarna performs a hard check whenever you apply for their ‘Financing’ option at 18.9 per cent APR.
Your credit score may take a dent, if the provider rejects your application. Potential lenders might see this as further evidence of your inability to manage your money. There’s also the problem of too many credit applications. It is recommended to limit credit applications to one or two per year. That is if you want to keep your credit score in pristine condition. With buy now, pay later, people are tempted to apply for much more.
When it comes to credit score health, though, they would be better off accessing alternative forms of lending. For instance, many online lenders now offer quick payday loans without performing hard checks or hurting users’ credit scores in other ways. You can learn more about BNPL alternatives with zero impact on your score and find the best deal for you.
Other ways BNPL might prove toxic to your credit score include the high-interest rates for some lines of credit. Some BNPL providers charge hefty interest rates (40 per cent – 50 per cent APR) for financing that allows you to spread what you owe over periods of up to 12 months. This can quickly snowball into a pile of debt. And you will no longer be able to make payments on time and will hurt your score.
In addition, BNPL is easy to access, and the risks are often downplayed. That’s why many young shoppers dent their score. Anti-debt charity StepChange has underlined that especially young and compulsive shoppers are at risk.
In 2018, the charity reported that 14 per cent of clients on the brink of a financial disaster were shoppers under 25. They also had an average debt of over £6,000. What’s more, many young people don’t have a steady source of income. So, it is easier for them to fall into debt and damage their credit score.