What you should know before the holiday season
If you’ve shopped online recently you might’ve noticed the checkout option to split your purchase up into 4 interest free payments.
These are called buy now, pay later (or BNPL) plans. They’re available at most online retailers now and they’re incredibly easy to use…but should you? That depends on a few things including the plan itself as well as your financial situation. While these services do provide some enticing benefits, there are some risks to be aware of before checking out.
With the holiday shopping season upon us, it’s important to be on your game with all the marketing about to be thrown at you. Many people use BNPL to fund their holiday shopping — in fact, a DebtHammer study saw BNPL usage go up 422% in November 2021 alone. Sheesh!
Unfortunately it’s very easy for your finances to get out of hand this time of year, but if you’re prepared with the right knowledge you have nothing to worry about.
In this blog we’ll break down exactly how BNPL plans work, the benefits, and the risks so you can evaluate if it’ll work for you. If you do decide to use these plans, we’ve also got some helpful tips on how to use them responsibly.
Let’s get into it!
What is buy now, pay later?
Here’s the deal with BNPL: it’s a form of debt.
Like the name suggests, buy now, pay later plans let you buy and receive something immediately but pay for it later, usually over a few installments. You typically owe the first payment at checkout and the remaining payments are billed to your debit or credit card until the purchase is paid in full.
The terms of repayment and how much interest or fees you’ll be charged varies between providers, however, most BNPL plans offer interest-free payments if you pay your full balance within a short period of time (typically 30 days) and little to no fees.
How buy now, pay later providers work
BNPL providers make their money from retailers. They essentially pay BNPL providers to make your checkout price look smaller.
It’s financial psychology and a little bit of marketing: if your $200 purchase was only $40 today, you might feel more inclined to buy more. Retailers are betting on you adding those extra items to your cart or buying something when you normally wouldn’t.
The official term for this is incremental sales and they’re a big part of BNPL business models because it genuinely works. It’s estimated that the offer of BNPL grows your shopping cart between 30 and 50 per cent on average.
Now, if you can afford the extra item and the larger payments fit into your budget there’s not really any risk to your short- or long-term financial health. However, many people end up spending and borrowing more than they can afford and that is a risk to your short- and long-term financial health.
It’s also worth noting that BNPL isn’t a new way to pay for something (ahem, infomercials). Fun fact: BNPL goes all the way back to the 19th century when Singer Sewing Machines sold its products for a “dollar down, dollar a week.” Even though it’s not new, it’s become exceedingly popular recently primarily because the pandemic has changed how we shop.
According to a report on 5 BNPL providers by the U.S. Consumer Financial Protection Bureau (CFPB), the number of BNPL loans in the U.S. has grown by 970% (16.8 to 180 million) from 2019 to 2021. The dollar amount for those loans grew from $2 billion to $24.2 billion. And that’s just America!
The benefits of buy now, pay later
The top reasons people use BNPL services according to a Financial Consumer Agency of Canada (FCAC) study are:
- to help budget
- to afford an entire purchase right away
- to avoid interest and fees
The added affordability is a key benefit of BNPL — it puts less of an immediate strain on your finances and you can make larger purchases than you otherwise would if you had to pay all at once. It can be a very convenient and disciplined way to pay for purchases over time.
BNPL is simple to use because it’s usually integrated into the retailer’s website. This is a benefit enjoyed by young people specifically as they often choose online retailers based on how easy it is to check out.
BNPL can also be used as a defense against the record levels of inflation we’ve been experiencing. Shoppers are able to use BNPL to lock in today’s price for their purchases, which could be particularly helpful in longer loans.
The speed at which you can get approved for a BNPL can also make the deal sweeter and add to the convenience: it only takes a matter of seconds. It’s likely you’ll get approved too — 73% of BNPL applicants were approved by 5 major providers in 2021.
Your credit score often doesn’t even matter. You can be eligible for BNPL loans if you have low or no credit (it just might affect how much you can borrow). Even if your credit score is high, BNPL loans usually don’t affect it because most BNPL providers only do soft credit checks on small and short loans. Also, BNPL providers typically don’t report on-time payments to credit bureaus, meaning small loans aren’t helping you build credit.
However, longer loans can impact your credit score if the provider requires a hard credit check — keep in mind these credit inquiries will stay on your credit report for 3-6 years. Though, if you’re making payments regularly and on time, the longer BNPL loans can actually help build your credit while avoiding the higher fees of credit cards.
Keep in mind, for smaller loans BNPL providers typically don’t report on-time payments to credit bureaus meaning they aren’t helping you build credit. This would be something to have a look at in the lender's policies before using it.
The impact on your credit isn’t the only risk to be aware of with BNPL services.
The risks of buy now, pay later
Unfortunately, it’s not difficult to get into more BNPL debt than you can handle
In finance, this is called overextension and with BNPL it can happen in two different ways: loan stacking and sustained usage.
This is when someone takes out multiple BNPL loans from different lenders and is unable to repay some or all of them. Unfortunately, the convenience and simplicity of BNPL services might be contributing to this behavior — there isn’t much stopping you from taking multiple BNPL loans from different providers at the same time.
Because most lenders only do soft credit checks, there’s no way for other BNPL lenders to know if the applicant has already taken loans out on other BNPL platforms. This means they aren’t rejecting those applicants that probably should for the sake of their financial health.
It doesn’t help that an increasing number of people are using BNPL for everyday or necessity purchases like gas and groceries. For some this is a personal choice, but for others it’s become necessary to stay afloat. Using BNPL too frequently can severely impact your financial health and get you trapped in a cycle of using more debt to pay off your debt.
This is the risk that someone’s frequent use of BNPL services may threaten their ability to meet other financial obligations, like rent, utilities, and other loans. Unlike loan stacking, which can happen instantly, the damage of sustained usage might take months or even years to appear.
Interestingly enough, the risk of sustained usage is stronger for people who actually pay their BNPL debts on time. This is because a BNPL provider will likely cut you off from future use with them if you’re missing payments — at least until you repay everything.
However, if you’re on top of your payments you can have continuous access to BNPL credit. Gone unchecked, you might realize one day that a large chunk of your income is going to BNPL payments.
Another feature of BNPL plans that doesn’t help the issue is that the better borrower you are, the higher your credit limits become — this just means you’re incentivized to spend even MORE.
Sustained usage isn’t a risk that’s unique to the BNPL industry, however, the structure of the BNPL service itself is amplifying it.
There’s a lack of standardization and regulation in the industry — every provider is different
With BNPL services, just about everything varies depending on the company from the terms of the plans themselves to the way they handle misuse. The industry is also still relatively unregulated, meaning you’re not as protected as you could be. Although as BNPL continues to grow we’ll likely see regulatory agencies step in at some point — in countries where BNPL is more established, regulators are already getting more involved.
All this means is that it’s absolutely necessary for you to read the fine print and know exactly what it is that they’re offering before signing anything.
Personal data concerns
As the industry evolves, BNPL providers are becoming very interested in your personal data and purchasing habits. Many companies are adapting their business models to include virtual and physical cards as well as virtual malls where you can browse endless products to take BNPL loans out for. Because of this, in a way, these companies are also advertisers and therefore have a strong interest in knowing how, when, and where you spend your money.
Lenders collect extraordinarily detailed information about you in a way that traditional cards can’t. They then use this information to make their virtual malls more personalized to entice you to spend more. Essentially, BNPL firms can leverage personal data to gamify shopping and lending, promoting repeat usage, which, as we already discussed, can lead to overextension for borrowers.
Consumer protection is currently weak
Because BNPL loans are fairly new, regulations have yet to catch up. So if something goes wrong, it can be more difficult to settle disputes or return products purchased with a BNPL loan compared to products purchased with a credit or debit card.
Lenders also often require you to sign up for autopay as a condition for taking out a BNPL loan or make it extremely difficult or impossible to remove. This can present challenges to some consumers who want more control over their debts. Additionally, it can inadvertently lead to overdraft fees from your bank.
Using BNPL responsibly
Even though these risks can be concerning, it doesn’t mean BNPL isn’t a perfectly viable option for you. The biggest thing to remember is that BNPL is a form of debt, so there’s a few things you should do to ensure you’re using it responsibly:
- Make every payment on time. Some lenders have late fees and for longer loans it can impact your credit score if you miss a payment. If you don’t think you have the discipline, maybe consider a different method of payment.
- Read every word of the terms of your loan and the policies of the lender. Pay attention to any administration, processing, or late fees and the interest rate as well as how the lender handles disputes. Keep in mind, plans and policies vary between lenders.
- Weigh the risks and benefits against those of other financing options.
- Consider the effect on your credit score — if it’s a long-term loan be mindful of hard credit checks that will remain on your credit report.
- Before you make the purchase, incorporate the payments into your budget to see if they fit. Consider if you can handle the amount and frequency and whether it fits with your other financial goals. This can help you avoid borrowing more than you can handle.
- Truly consider what’s going into debt for. You might be feeling the social pressure this holiday season to spend on gifts and parties but sacrificing your financial wellness to keep up with societal expectations isn’t ideal.
- Avoid taking out multiple loans in a short period of time and consider not using them for regular purchases like groceries as that can quickly lead to overuse.
- Consider only using BNPL for large, one-time purchases or emergencies.
- Consider the effects of BNPL marketing: A $400 purchase is the same amount of money out of your account as 4 payments of $100. Whether or not that’s a good deal depends on your financial situation and ability to be disciplined paying it back. Remember: a good deal you can’t afford isn’t actually a good deal.
The bottom line
The main idea of BNPL is that consumers can get the things they need (or want) immediately while also getting extra time to pay for them. This can be incredibly appealing, but it’s important to remember that BNPL is a form of debt and when dealing with debt you have to be disciplined. It’s completely possible to use BNPL responsibly, but informing yourself of the risks and reading the fine print of any plan beforehand is absolutely necessary.
If you want to learn more about the BNPL industry, the Consumer Financial Protection Bureau (a US government agency that protects consumers in the financial sector) has a detailed report filled with even more valuable insights. If you have the time, it’s definitely worth the read.