Is 'buy now, pay later' too good to be true?

For generations, retailers have offered customers the opportunity to make a purchase today and pay over future installments. Who can forget layaway departments, or the promise of "three easy payments of $19.99"? Call it, the "buy now, pay later," or BNPL, philosophy.

During the pandemic, when people were stuck at home and e-commerce sales surged, consumers turned to new BNPL technologies to make their purchases more accessible.

"Buy now, pay later offers a good news, bad news scenario, depending on your financial habits," says Robert Steen, USAA Advice Director. "If you typically spend within your budget and are committed to making on-time payments, BNPL might be a useful strategy. But if you're the kind of person who sometimes misses a payment, it could really hurt your finances."

Whether it makes sense for you, it's hard to deny that BPNL is here to stay. These pay-over-time apps accounted for 2.1% of e-commerce transactions worldwide in 2020, according to technology provider Worldpay, Inc.^{See note1} And by 2024, that number is expected to double.

Read on to learn more about BPNL so you'll be prepared the next time you make a purchase.

How does BNPL work?

Traditional layaway plans had their heyday after the Great Depression and continued in popularity until credit cards gained steam in the 1980s. Unlike layaway, where the retailer holds your purchase until you've finished paying for it, BNPL lets you take your purchase at the time of the transaction.

Whether you refer to it as BNPL, buy now pay later loans, pay-over-time apps, installment payment apps, pay-later sites or payment plan apps, the concept is basically the same: You pay for your purchase in a series of installments — usually four even payments every two weeks — with zero-interest financing.

Zero-interest financing is the reason most BNPL shoppers prefer the technology. It was reported that 39% of shoppers are turning to BNPL to avoid paying credit card interest, according to technology provider Worldpay, Inc.^{See note1}

Let's say you've found a new $200 coat from your favorite online retailer. When you pay, you see a BNPL payment option that allows you to pay $50 today, followed by another $50 payment every two weeks for six more weeks. As long as you make your payments on time, you don't pay interest. But if you miss a payment before the interest-free period ends, you face big late fees and interest charges.

Some of the most familiar BNPL apps include Klarna, Affirm, Afterpay and Sezzle. Each varies slightly when it comes to some of the details. Affirm, for example, doesn't charge late fees, but you aren't allowed to use the service if you have outstanding charges. Afterpay and Klarna charge late fees, but they're capped. And some, claiming they don't charge interest, actually only offer "interest-free" periods.

Additionally, most BNPL companies don't run hard credit checks before allowing you to open an account. Some run a "soft pull" as part of the approvals process, but a soft pull won't impact your credit score.

BNPL versus credit cards

When consumers use BNPL technology, they're more likely to spend more. According to Afterpay and PayPal's BNPL feature, the technology raises the average order value by up to 20%.^{See note1} Retailers are now willing to pay the BNPL company a small percentage of the transaction value — just like they do with credit card transactions.

Unlike credit cards, which can generally be almost everywhere, most retailers partner with one BNPL company. For that reason, consumers who like to use BNPL have accounts with multiple BNPL providers.

"That's another area where things can get tricky with BNPL," warns Steen. "As a customer, you're responsible for keeping track of when your outstanding payments are due, and if you have one account with Klarna, for example, and another with Affirm, and another with Sezzle, you could load up on debt and overdraw your bank account."

Worse still, some consumers enter into a chain of borrowing and turn to credit cards to service their BNPL debts. Steen points to a study that found 15% of BNPL users had to take out another loan to make their payments, according to the Australian Securities and Investments Commission (ASIC).^{See note1}

"If you're drawn to this technology because it allows you to make interest-free purchases, that really backfires when you're forced to use high-interest-rate credit cards to pay your bills," he says.

How can BNPL impact your credit?

In the event that you default on your payments, most BNPL companies will close your account and demand that you pay your remaining balance immediately. "If you don't, they'll send your debt to collections, which is bad news for your credit rating," says Steen.

According to Steen, there's traditionally been another big downside to BNPL vs. credit cards: "Until recently, making on-time payments wouldn't help your credit. That's because BNPL providers didn't report positive payment history to your credit report."

Generally, this is still the case. Recently, however, credit agencies have considered adapting their policies regarding how to incorporate BNPL transactions in their credit reports. Equifax® was the first to declare that it would implement a new "business industry code" for BNPL. In other words, Equifax plans to invite BNPL providers to report transactions for inclusion on traditional consumer credit reports.^{See note1}

The change is expected to come as early as 2022.

Balance the rewards with the risks.

BNPL isn't necessarily a bad option. Taken at face value, no-interest loans can be useful. If you have plenty of money in your bank account to cover your purchases or you're spending within your budget, it's possible that BNPL could be a responsible way to save money. This is especially true if it allows you to defer paying all at once with no interest or fees, so you can use the "lenders" money in the short term, instead of tying up your own.

But if BNPL is used as a crutch to pay for products you can't afford, it's just enabling overspending.

In December, Affirm, Afterpay, Klarna, PayPal and Zip collected information on the risks and benefits of BNPL credit after being ordered by the Consumer Financial Protection Bureau (CFPB).^{See note1} The CFPB issued these orders out of concern that BNPL technology causes:

• Consumers to spend more than anticipated because of the ease of getting these BNPL loans.
• BNPL providers to skirt current consumer protection laws, such as providing certain disclosures or dispute resolution protections.
• BNPL providers to harvest data from consumers, using valuable payment history of their customers to create closed loop shopping apps and push specific brands and products.

At the end of the day, options like BNPL make it easier to overconsume.

"As simple as it sounds, spending less than we earn goes against our hardwiring, which is to consume, consume, consume," says Steen. "Even when we're spending within our budget, we have to remember that buy now, pay later apps are very new and consumers are taking a risk when they rely blindly on them to make purchases."

The USAA Advice Center provides general advice, tools and resources to guide your journey. Content may mention products, features or services that USAA Federal Savings Bank does not offer. The information contained is provided for informational purposes only and is not intended to represent any endorsement, expressed or implied, by USAA or any affiliates. All information provided is subject to change without notice.