American consumers who have thousands in credit card debt oftentimes end up in debt not because they bought one large extravagant item, rather they were accidentally living beyond their means on a monthly if not daily basis. Purchasing too many items because “It’s only…”
While Buy Now, Pay Later programs originated as an alternative to credit cards and high-interest payday loans, it turns out that these micro-installment loans are not as affordable as they may originally sound – especially once you add up all of your Buy Now, Pay Later (BNPL) purchases together.
Sure, four payments of $25 may make those $100 shoes much more financially digestible at the onset. But what happens when you say “It’s only…” $25 five or six times and now you can’t afford all of these Buy Now, Pay Later payments simultaneously?
It’s an issue more and more consumers are experiencing as more turn to BNPL programs to pay for goods and services.
The Downside of Buy Now, Pay Later
1. Missed Payments
BNPL options originally seemed like an affordable way to finance costlier purchases for those who didn’t have a credit card, didn’t have access to affordable interest rates, and/or were trying to avoid credit card debt.
In fact, Afterpay was designed for millennials or at least those who subscribe to the millennial value system of not being dependent on a credit card, according to the company’s founder Nick Molnar, an Australian entrepreneur.
Molnar and supporters of BNPL argued that these services allowed individuals to make their own decisions by doing a “gut check” on what is right for them, with instant feedback. But many others, including financial professionals, disagreed that the benefits of BNPL outweighed the risks.
“These services can be pretty dangerous. They’re playing on our desire to have something outweigh the actual calculations of what we can afford,” says consumer psychologist Kit Yarrow. “Splitting the payments up can trick us into thinking those $200 boots are only $50, because that’s the payment we see, and we rationalize that it is only $50 for now.”
Yarrow has a point. According to a recent Reuters/Credit Karma survey, nearly 40 percent of U.S. consumers who had used Afterpay, Klarna, Affirm, or one of the many other BNPL services, had missed at least one payment. That means that almost half of all persons who have used BNPL have missed a payment.
Late fee charges vary based on the BNPL servicer. Some may not charge you a late fee rather they will limit your ability to use that BNPL service moving forward. However, some missing payments may impact your credit score.
2. Credit Score Impact
While BNPL servicers are not held to the same requirements and restrictions as credit card companies, some like Afterpay include in their terms of service that the company has the right to run credit checks on consumers. The company can also “report any negative activity on your account (including late payments, missed payments, defaults, or charge-backs) to the credit bureaus.
In other words, your Afterpay charges and payments may actually have a greater impact on your credit score than you ever imagined. You could end up having your debt sent to a third-party debt collector, negative marks on your credit report could prevent you from being able to borrow money from a lender, or at least borrow the money at a reasonable interest rate.
“When it comes to missing payments, the main focus of the score is how recently the payment was missed, and how seriously delinquent the payment was,” said Ethan Dornhelm, vice president of Scores and Predictive Analytics for FICO. “And so to that end, missing payments is likely to have a significant impact on a consumer score.”
Although BNPL emerged as a way to get away from the world of credit cards and credit scores, your BNPL servicer can make or break your credit score.
Of the 40 percent of American consumers who reported they missed a BNPL payment, about 75 percent saw their credit score take a hit as a result of that missed payment.
How is that possible?
Whenever you use one of these BNPL services, the company is running a soft credit check before you’re approved.
“When a soft credit check is performed, we verify a customer’s identity using the details they provide, and we look at information from their credit report to understand their financial behavior and evaluate their creditworthiness,” explains a spokesperson from Klarna.
But some BNPL services do use a hard credit check.
For example, Affirm offers a 0 percent APR option with four biweekly payments and no credit check, but its longer-term installment loans rely on a hard inquiry. PayPal’s “Pay in 4” only uses a soft credit pull, but PayPal Credit does a full credit check.
It’s important to understand those distinctions when you’re presented with different payment options at checkout because applications for new credit accounts for 10 percent of your FICO score calculation.
“Analysis of millions of credit files that we use to build our FICO scores consistently shows that those with higher numbers of recently applied-for accounts and recently-acquired accounts do represent a slightly elevated risk of retainment down the line,” says Dornhelm.
Of course, one hard inquiry isn’t going to tank your score. “But for a rare segment of the population, that could be a meaningful impact,” Dornehlm said.
If you’re applying for a mortgage or refinancing, for example, just a few points could put you into a different interest rate tier, which could either cost or save you thousands of dollars.
The problem? “Nobody’s reading the fine print,” says Howard Dvorkin, CPA, and chairman of Debt.com. “Either you’re checking out on a terminal or on your computer or phone, and the screen is small, and you’re not going to sit there and read this lending language.”
The bigger issue is if you take out loans that use hard inquiries regularly. “If they report and you go out and get five of these loans, it looks like you’re desperate for credit,” says Dvorkin. “You have to be very careful.”
Not all BNPL programs report your activity to the credit bureaus. So keep in mind that if you miss a couple of payments but then catch up, your score might come away unscathed.
Of course, if the BNPL does report, once you miss a billing cycle, it will likely show up as a negative item on your credit report and trigger a score drop.
To lessen the impact on your credit score while using BNPL, the financial experts at Bankrate recommend you answer these three questions before you sign up for a BNPL service:
- Will your payment activity be reported to the credit bureaus?
- Does the service run a hard or soft inquiry when you apply?
- What happens with late or missed payments?
3. Spending More Money
Credit cards are infamous for getting us to spend more than we would have spent if we had paid with cash. Turns out a similar phenomenon exists with BNPL too. Those who use BNPL services typically spend 18 percent more than they would have if they were paying with cash.
“Don’t be fooled into thinking that this might be better than a credit card,” said Effie Zahos, Canstar’s Financial Consultant and Editor-at-Large. “Buy now, pay later services are loans. And given the uncertainty of the current climate, it’s best to think of other options,” she said.
“My advice in approaching buy now, pay later services is that if you can’t afford it now, you’re not going to be able to afford it in two weeks. Perhaps if you are using it for essential services, and you can be sure you can pay it off, you may want to consider it. But now is not the time to be purchasing a new pair of shoes or some new loungewear using buy now, pay later.”
4. Good Luck with Returns
If the missed payments, credit score impact, and increased spending don’t seem like much of a disadvantage, consider the hassle with trying to return a BNPL-financed item.
It’s actually become so difficult to return BNPL-purchased goods that people who use BNPL services return fewer items overall than those who use a traditional credit card. A spokesperson from Afterpay confirmed that this is what they hear from retailers but added that the company had not been tracking return data themselves.
However, we should note that data is lacking on this topic, but hopefully, that will soon change as the Consumer Financial Protection Bureau (CFPB) issued a series of orders in 2021 to the BNPL companies requiring them to compile an overview of the risks and benefits of using their services.
While you may not buy an item with the intent of returning it when using BNPL, the truth is that even the smartest shoppers end up making a return once in a blue moon. And as many shoppers are discovering, returning an item you purchased with BNPL-financing can be an absolute nightmare, if not impossible.
Part of the reason it’s so hard to return BNPL purchases is that it’s up to the individual retailer to decide how the purchases must be returned. Some allow in-store returns for items purchased online, some require you to start the return process on the app but can finish in-store, while others require you to return the item using the BNPL app only.
Even how the money is returned to the consumer varies from retailer to retailer.
Another headache for consumers? The inability to dispute purchases.
Anyone who has a credit card in their name has the ability to dispute a charge that you disagree with. You might want to dispute a charge if, for example, you feel that the quality of an item wasn’t what you were promised, or if the goods or services you bought were never delivered to you.
When you start a dispute, the credit card company can reverse the charge, giving you your money back, which then forces the merchant’s hand to make good on their promises to you, whatever they were. But when you use BNPL services, you’re completely stripping yourself of those rights, explains Joe Lynyak, Partner at the law firm of Dorsey & Whitney and an expert on the Consumer Financial Protection Bureau and regulatory reform.
“BNPL companies offer a credit-like product that can have whatever terms and conditions their company wants to impose,” Lynayak says. The BNPL company has “no obligation or skin in the game” to get in the middle of a dispute, Lynyak explains. “This is why the best way to purchase something expensive is to use a credit card so you have leverage in the case of a dispute.”