Buy now pay later apps are beloved by consumers. Should users be worried about high debt?

Buy now, pay later on cellphone.
Katie Wedell

Brittany Anderson Givens started using buy now, pay later services like Zip to help spread out the cost of household bills over several paychecks.

When the pandemic hit, Givens, of Memphis, Tennessee, couldn’t work because she’d just learned she was pregnant with her second child and the guidance about COVID-19 and pregnancy was unclear.

Her husband’s hours became unpredictable.

“We had to pay a light bill during the pandemic that would have been hard,” she said.

Splitting the bill up over four payments helped them out without adding to their credit card balances.

“I don’t have the best credit… if we had to go through a credit check to do that, it wouldn’t help us at all,” she said.

She’s continued using pay-in-four apps ever since – Zip for splitting up bills, Sezzle for going on Target runs.

The convenience of being able to pay over six weeks with no interest allows her to buy some nice things for herself, like new clothes from Shein, without impacting her credit score.

Although customers like Givens love financing everyday purchases with "buy now, pay later" apps, consumer protection groups and financial experts have been sounding the alarm on these relatively new companies on the payment scene.

They say a lack of regulation could lead to people going into debt without the protections in place that other lenders have to follow.

Consumer protection agency digging into Affirm, Afterpay, Klarna, PayPal, and Zip

Late last year, the U.S. Consumer Financial Protection Bureau announced an inquiry into buy now, pay later products and business practices. 

The federal government’s arm that previously cracked down on payday lenders who took advantage of consumers with exorbitant interest charges now wants to know what risk the proliferation of BNPL services could pose to users. 

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BNPL offers customers the ability to pay off purchases in four or more installments, often interest-free. The number of companies offering these short-term loans has exploded in recent years, accelerated by the increase in online shopping during the pandemic.

“It’s actually hard to pay for anything online without being offered the chance to pay in four easy payments over time,” said Marshall Lux, a research fellow at the Harvard Kennedy School.

A BNPL service typically requires an initial payment of 25% of the total purchase price, and then sets up automatic payments from the buyer’s credit or debit card for three additional payments every two weeks. For the most part, these loans do not require a credit check and are not reported to the credit bureaus.  ​​

In a report published in April, Lux urged more oversight of the BNPL industry.

“I'm not claiming that anyone is acting incorrectly, that any of the big companies are doing the wrong thing,” Lux said. “But bad actors can do the wrong thing. And I worry about this part of society that is most vulnerable to getting in trouble. I worry about young people messing up their credit. I worry about people who can least afford this.”

The consumers who use BNPL tend to be younger and make lower-than-average income, according to Lux’s research. But the growing industry is becoming more popular with all age groups.

In fact, 60% of U.S. consumers said they intended to use BNPL products in the coming year, according to a survey by McKinsey and Company management consulting firm last summer.

BNPL purchases accounted for 2.9% of global e-commerce transactions last year –  more than $142 billion – according to a report from Worldpay, the payment processing firm owned by FIS. Worldpay expects that figure to double to 4.2% by 2024 while other estimates are even higher. Market research by Kaleido Intelligence projected BNPL to account for $680 billion in transactions by 2025, representing 12% of all e-commerce sales on goods. 

More BNPL products are being announced, with Apple last week unveiling its own installment payment plan, Apple Pay Later

Retailers love it because it increases their sales. RBC Capital Markets reported in 2021 that online BNPL increased conversion rates by 20-30% and lifted average sales per transaction by 30-50%. The conversion rate is the percentage of people who visit a store and end up purchasing a product. 

And consumers love having the ability to spread out payments and increase their purchasing power, especially people labeled by the credit industry as subprime borrowers, or those with poor credit histories, who often feel weighed down by a three-digit number they don’t completely understand.

No timeline for federal recommendations on buy now, pay later

Some don’t want to see BNPL governed by the same credit-reporting regulations as traditional products.

The credit-monitoring companies, "really want to find a way to like control people and make more money from monitoring people’s credit,” Givens said. 

But credit counselors like Rachel Klopfer in Springfield, Ohio, are starting to see clients who have gotten in trouble using BNPL services. They’ve got multiple loans out at once, adding to their overall debt burden.

“They think it’s helping because they’re not adding to their credit card debt… but it’s strapping their cash,” she said of those who make their payments with their debit card. 

The CFPB’s inquiry is collecting information from five companies offering BNPL loans: Affirm, Afterpay, Klarna, PayPal and Zip.

“Buy now, pay later is the new version of the old layaway plan, but with modern, faster twists where the consumer gets the product immediately but gets the debt immediately too,” CFPB Director Rohit Chopra said in announcing the inquiry.

A CPFB spokesperson said in late May that there is no timeline for completing its inquiry or releasing a report of the agency’s findings. Such a report could include recommendations for new regulations for the BNPL industry.

How does Buy Now Pay Later work?

Klopfer, the credit counselor, said it’s only recently that she’s encountered loans from Affirm and other digital BNPL services when talking to clients, but the concept isn’t new.

A decade ago, she remembers counseling a woman who had numerous payment plans from a catalog that offered to spread out payments.

Mail-order companies like Fingerhut and Stoneberry have offered payment plans with no minimum credit score required for decades.

Many cellphone users get the newest smartphone from their carrier and pay installments on it each month along with their network plan. And retailers like Lowe’s, Sears and Walmart have offered either lease-to-own or layaway payment options.

The difference between layaway and BNPL, however, is that with layaway, you don’t receive your purchase until after the last payment is made.

Additionally, while consumers have long been able to finance large purchases like furniture and electronics through stores, that usually involved a credit check to qualify. 

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BNPL companies including PayPal, Affirm, Klarna, Zip, Afterpay, Sezzle, Shop Pay and others make money by partnering with merchants who pay them a fee every time the company facilitates a purchase.

Sellers benefit from these partnerships through increased visibility on the BNPL sites and because people spend more.

“Klarna makes money by charging retailers a small fee to offer our services to their customers, similar to those retailers already pay for credit card transaction processing,” a company spokesperson said.

Klarna says its global retail partners received 301 million clicks from consumers via the Klarna app in 2021, more than double the traffic from the app compared with 2020.

While most BNPL companies offer interest-free, short-term loans, some have longer-term options that do charge interest, providing an additional profit stream.

When a customer purchases an item and chooses to pay in four installments, the retailer gets paid the full amount by the BNPL company. The customer's future payments are repayments to the bank that backed the loan for the BNPL company.  ​​​​

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Do Buy Now, Pay Later purchases impact your credit score?

But is a BNPL user's credit score affected? The short answer is yes, potentially.

For the most common BNPL plans, the companies lending the money say they do not do a hard inquiry of your credit report and do not report the loan to the credit bureaus.

A hard inquiry or hard credit check is typically done by a lender to determine your eligibility for a loan, according to Credit Karma. It can lower your credit score, especially if you have multiple hard inquiries in a short amount of time. A soft inquiry is more typically done for background checking purposes and does not have any impact on your credit score. 

Most BNPL lenders check your credit history via a soft inquiry. 

Equifax announced a formalized process for including BNPL on traditional U.S. credit reports late last year, enabling BNPL providers the option to report the popular “pay-in-four” loans beginning Feb. 28, 2022. But it's not mandatory.

Experian, meanwhile, created a separate bureau for BNPL providers to share payment data. Payment history and the number of BNPL loans taken out at a time can be tracked, but all the information is stored separately from Experian's normal credit bureau data, shielding consumers’ scores from negative impact.

The big three consumer credit bureaus have all said they are in communication with BNPL companies to develop standards for this new industry. 

An Affirm spokesman said they welcome these discussions. 

"Reporting to credit bureaus helps protect consumers and build their credit histories," the spokesman said. "It also enables all responsible underwriters to more accurately assess risk and help prevent consumers from being overextended."

How loans are reported to credit bureau impacts your credit score

BNPL plans that charge interest or are spread out over more than four payments may be reported to the credit bureaus as “closed end” loans.

This is an important point, according to Chi Chi Wu, a staff attorney at the National Consumer Law Center

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Factors like the amount of time an account has been open and how much credit is available count favorably on your credit score, Wu said. A short-term loan that gets paid off and closed out after a couple of months and was for a relatively small amount will not do your credit score any favors.

“Those factors may not look great if the BPNL loans are reported as a series of short-term installment loans or closed-end loans,” Wu said.

If more regulations are placed on the BNPL industry and more of these loans are reported to credit bureaus, it could hurt consumer scores, even if the loans are paid off on time, she said. 

However, if these loans were to start to be regulated more like credit cards, and reported as revolving lines of credit, then paying them off on time could be a way for consumers to build their credit score in the future, Wu said.

If you fail to make the payment on your BNPL loan, the companies can send the debt to collections, which would appear on the consumer's credit report.

What are the benefits of using Buy Now Pay Later?

For customers who don’t qualify for traditional credit cards, have low credit limits or are working to pay off maxed-out cards, BNPL cards offer a way to finance purchases without involving the credit bureaus, in most cases.

The ability to pay over time might allow someone to jump on a deal – like a suddenly much cheaper flight or concert tickets that are selling out fast – without having to have the full amount on hand at that moment.

And most plans are set to be paid off over six weeks instead of the 30-day limit to pay off a credit card purchase with no interest.

The companies offering these loan products also say they are more transparent than traditional credit card companies.

“We show the exact amount a consumer will pay upfront, and that amount never increases,” an Affirm spokesman said. “We don’t charge any late or hidden fees.”

Unlike a credit card with a limit of thousands of dollars, BNPL companies use algorithms to approve each individual borrower on each individual transaction.

“One of the foundational ideas behind our company is that revolving lines of credit – while unbelievably convenient – aren’t really good for most people,” said Affirm’s CEO and founder Max Levchin in a recent blog post. “With cards, once you carry a balance, you pay interest on every single thing you buy – a couch or a cup of coffee. Calculating what purchases really cost you is near-impossible.”

He said this ambiguity is a key reason many Americans’ have a bad relationship with debt.

“Credit cards make it easy to spend, hard to pay off your ever-compounding balance, while hiding their profit margin in the fine print and complicated math,” Levchin said.

Customers like Givens know that credit card companies make their money on the interest and fees they charge and are wary of carrying too much credit card debt.

She doesn’t know anyone who has gone into debt due to BNPL.  

“I don’t think they need to monitor this stuff because it’s helping,” she said. “It’s something a lot of people like.”

What are the financial risks of using Buy Now, Pay Later?

As part of its inquiry, the CFPB opened up public comments on BNPL. A letter signed by 77 consumer-focused organizations lays out numerous concerns.

Critics worry BNPL companies are not adequately assessing a consumer’s ability to pay back a loan.

“Although some providers run a ‘soft’ credit check, others do not check credit at all,” the letter says. “Many BNPL providers offer the first extension of credit with a limited assessment of the consumer’s current obligations.”

Another issue is accessing a refund if a consumer is unhappy with or wants to return a product when the purchase is going through a third-party BNPL company.

The letter also expresses concern about some BNPL companies charging late fees, missed payment fees, account reactivation fees, returned payment fees, and rescheduling fees that are not clearly disclosed to consumers.

Lux has the same criticism.

“The prices aren't always apparent,” he said. “What happens if you don’t pay on time isn’t up front and out there.”

BNPL companies counter that most don’t charge any late fee for a missed payment.

"We ensure all Pay Later plans can be easily managed and paid within the PayPal app, never charge late fees for missed or delayed payments, and ensure constant communication to users about upcoming payments and payments made," a PayPal spokesperson said. 

Customers using BNPL apps can get notifications on their phones about coming payments and see all their payment plans displayed in the app dashboard. 

Lux also worries that people are able to open so many loans at once. Even if one company denies a new BNPL plan, a different company could say yes, and consumers may have difficulty keeping track.

“Increasingly these are people paying for things like sneakers or jeans or sweaters or other apparel. Or, you know, in some cases, cleaning supplies,” he said. “To someone who understands risk well, that's a telltale sign that people are skating on thin ice.”

A 2021 survey by market research company C+R Research found that 59% of respondents said they purchased an unnecessary item via BNPL that they otherwise couldn’t afford.

Klopfer worries that these loans are being given to people who do not have their spending habits under control and that’s why they are not able to qualify for credit.

Speaking of one client who's used BNPL loans, Klopfer said that if you ran his credit “ you would not give him another credit card. You would not sell him a car or sell him a house.”

Givens in Tennessee said she had an issue only one time, where she’d put multiple bills on payment plans at once and became worried she and her husband might not have enough in the checking account when those payments were due.

“So that was the only time we were kind of like, we might have bitten off more than we can chew,” she said.

She noted that the companies do have customer service lines to call if there is an issue with a payment. Some offer the option to move a payment back a week up to once per loan.

What changes could be coming to Buy Now, Pay Later?

Lux’s report recommends several regulatory changes that could help make the BNPL industry safer for consumers.

He recommends mandatory fees and rights disclosures at point-of-sale to help consumers understand the real cost of BNPL financing and to make clear that BNPL products lack the consumer protections of similar products, like credit cards.

He and other commenters have also recommended uniform credit-bureau reporting standards, charge-dispute settlement procedures, and data privacy standards as some BNPL companies are selling consumer data.

Most of the recommendations boil down to one thing: Treat BNPL like a credit card.

While Equifax has touted a study showing a majority of consumers experienced an average FICO score increase of 13 points when they made on-time BNPL payments, the coalition letter calls for more research into the realistic impact of BNPL on credit scores.

“This increase was due in part to consumers choosing to have the BNPL account reported as a revolving account, like a credit card,” the letter says. “The credit-building potential of BNPL is significantly limited given how frequently opening short-term loans (even if they are paid on-time) has a negative effect on credit scores, as opposed to the positive effects associated with managing timely payments on a revolving, open-end credit account.”

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