If you shop online, you’ve probably noticed the increasing presence of new options on the checkout pages of major retailers.
Companies such as Affirm, Afterpay, Klarna and PayPal offer “buy now, pay later” loans that allow you to purchase items with little or no money upfront.
“Buy now, pay later” is exploding in popularity in the United States. However, there are harsh financial risks associated with the concept.
In this article, I’ll explain how “buy now, pay later” (BNPL) works, examine the consequences for missing payments and tell you why money expert Clark Howard thinks these companies are bad news.
Table of Contents
- What Is ‘Buy Now, Pay Later?’
- How Does BNPL Work?
- ‘Buy Now, Pay Later’: Clark Talks Risks & Consequences
- Comparing ‘Buy Now, Pay Later’ Options
- When Does ‘Buy Now, Pay Later’ Make Financial Sense?
- BNPL Pros
- BNPL Cons
- Alternatives to ‘Buy Now, Pay Later’
What Is ‘Buy Now, Pay Later?’
“Buy now, pay later,” also known as an installment or point of sale loan, is a way to finance purchases.
“It’s when you get to a register in a store, or you’re shopping online, and at the last second, you’re offered an option of not having to pay for what you’re buying. I mean, is this a great country or what?” Clark said on a recent podcast.
“That item you’ve got there, that new piece of electronics or that new purse or that shirt or blouse or that dress: You don’t have to pay for it. You can just walk out with it right now.”
Installment loans aren’t new, but “buy now, pay later” (BNPL) is relatively new in the United States. According to Business Wire, Americans are expected to spend $82.1 billion on buy now, pay later in 2022. That’s up about four times from 2020 according to Bloomberg, which cited analytics firm CB Insights, projected that U.S. consumers could spend $1 trillion through BNPL by 2025.
Gigantic companies such as Amazon, Nike and Walmart are offering “buy now, pay later” financing. And the BNPL companies themselves claim to have thousands of retail partners.
BNPLs market themselves as credit card alternatives. But the shiny object for consumers is the ability to purchase something online or in person and get the item while paying little to no money upfront.
“Because of human behavior and psychology, this is going to continue to grow like wildfire,” Clark says. “It’s going to spread like crazy.
“And people are going to use this by the many hundreds of billions of dollars. But it doesn’t mean they should be doing it and that it’s a good idea. Because it’s not.”
How Does ‘Buy Now, Pay Later’ Work?
Often, but not always, BNPL involves a 25% down payment — then three more equal, interest-free payments, one every two weeks.
Among the BNPL companies I’ve reviewed, it’s possible to finance an item that costs as little as $10 and as much as $17,500.
The potential negative consequences include wrecking your credit, paying late fees, paying interest and just plain spending too much money.
BNPL companies make money through late fees and by collecting interest. But they often make the majority of their money by charging merchants for every purchase (typically between 4 and 6%).
“Think about this from the merchant’s standpoint. A merchant, if they take credit cards, is usually going to pay 1.25% to 2.5%,” Clark says.
“They’re willingly stepping into something where they’re paying 6%. And the reason they’re doing it is they believe that it gets people to make purchases they wouldn’t make otherwise.”
‘Buy Now, Pay Later’: Clark Talks Risks & Consequences
Each “buy now, pay later” company offers a different set of rules and consequences.
Which is worse: messing up your credit, paying interest and late fees, contending with a debt collection agency or getting banned by a BNPL company?
“You’re asking, ‘Do I want to die from a knife, a gun or a guillotine?’ when you talk about ‘Do I want to ruin my credit, do I have to have to pay interest or do I want to have to pay late fees?” Clark says.
“These things have so many negative consequences to them. I don’t want to be Scrooge, but these things are playing with fire.”
Let’s breeze through the potential consequences.
1. Overspending. Clark says the biggest danger may be spending money you don’t have.
“People are more likely to buy something impulsively they might not [otherwise buy] because somehow, suddenly it feels like, ‘Hey, you’re letting me walk out of the store with this. I don’t have to worry about it,'” Clark says.
“And so I think it leads to overspending.”
2. Wrecking your credit. If you’re late on a payment, most BNPL companies will report you to one or more credit bureaus. Most or all of the companies that report to credit bureaus offer some sort of grace period. But the timing on that grace period isn’t always apparent to the user. Nor is it worth rolling the dice on it.
Most BNPL companies don’t default to automated payments, either. So it’s easy to forget when your payments are due. It’s also possible that a missed payment can stay on your credit report for years or that it can lower your credit score.
3. Interest. Many BNPL companies don’t charge interest, especially for the standard “pay in four” structure. However, I’ve seen interest rates as high as 30%. That’s much higher than the average credit card interest rate, which is 16.7% as of June 2022.
At least BNPL companies charge simple rather than compound interest.
4. Late fees. Some “buy now, pay later” services don’t ever charge late fees. Others charge late fees maxing out at 25%. BNPL companies that charge fees often cap them. And the majority of BNPL services don’t allow first-time users to finance more than several hundred dollars.
As a percentage of your purchase, fees can be steep. But as a dollar amount, they’re typically low. For example, paying a $10 fee that’s 25% of your purchase is relatively minor as a consequence compared to ruining your credit.
5. Debt collectors. Default on your loan by remaining delinquent on your payment(s) for too long, and the “buy now, pay later” service may refer your account to a debt collector. Contending with a debt collection agency doesn’t seem pleasant.
6. Getting banned as a user. If you miss payments, BNPL companies can reduce your credit limit or ban you outright. This may not be such a negative consequence. It may prevent someone from buying something they can’t afford and/or prevent more missed payments in the future.
Comparing ‘Buy Now, Pay Later’ Options
It’s important to know which “buy now, pay later” companies charge interest, late fees and report missed payments to credit bureaus.
These companies aren’t exactly going to give you a pop-up warning when you select them the next time you buy a coffee table online.
Here’s a comparison between four of the biggest BNPL operations in the United States.
| Afterpay | Affirm | Klarna | Pay in 4 | |
|---|---|---|---|---|
| Interest Rate | 0% | 0-30% | 0-29.99% | 0% |
| Term Length | 6 weeks | 1 to 48 months | 6 weeks to 36 months | 45 days |
| Loan Amount | About $500 initially Increases with positive history | Up to $17,500 | Minimum $10 No defined limit | $130-$1,500 |
| Late Fees | Up to 25% | None | Up to $7 (Max 25% of payment) | None |
| Credit Bureau? | Never reports | Reports to Experian | Can report late payments | Can report late payments |
| Automated Payments? | No | No | No | Yes |
When Does ‘Buy Now, Pay Later’ Make Financial Sense?
At least on paper, if you can get an interest-free loan, there are certain situations where BNPL makes mathematical sense.
Let’s say you’re trying to pay off high-interest credit card debt. Deferring 75% of your cost on an item for at least a few weeks may allow you to put extra money toward your debt, which is accruing interest.
However, Clark has found flaws in that idea.
First, he points out, you’re putting your credit at risk.
The strong majority of the “buy now, pay later” services I’ve reviewed don’t take your payments automatically. You can set up automatic payments yourself. You can pay off the entire balance prior to any of your due dates. Or you’ll have to remember to make all your payments manually.
“It’s completely true that, as much as I don’t like people to do automatic payments, the only smart way to do these is to do automatic payments,” Clark says.
The financial consequences of missing even a single payment can be harsh. And according to Credit Karma, more than one-third of Americans who have used BNPL have fallen behind on at least one payment. Clark finds that “worrisome,” especially since 72% of those people believe their credit score declined as a result of missing the payment(s),” according to Credit Karma.
Second, if you’re carrying high-interest credit card debt, it may be a bad idea to make any optional purchases.
“I would say if somebody has big balances on high-interest credit cards and they’re looking at buying something else, the answer is they don’t buy anything discretionary right now,” Clark says.
“I mean, if your refrigerator dies and you have to replace your refrigerator, maybe you’re right. But if it’s discretionary spending and you already have an unpaid, high-interest balance on your credit card, the answer is you don’t buy anything until you’ve got that under control.”
BNPL Pros
Here are the most positive aspects of the “buy now, pay later” industry:
- Potential for interest-free financing. Some BNPL options allow you to get an interest-free loan. At least in a vacuum, those are magic words.
- Involves most major U.S. brands. This wasn’t the case as recently as three years ago. But as of right now, it’s hard to find a big, recognizable brand that doesn’t offer a “buy now, pay later” option.
- Can help those with no credit or bad credit. This sounds a little like a sleazy car dealership TV commercial. Bad credit? No credit? We can beat your best deal regardless. OK, I got carried away with that last sentence. But if you need alternative financing, or if you don’t trust traditional financial institutions, BNPL offers another option.
BNPL Cons
Here are the biggest downsides to the “buy now, pay later” industry:
- Risks hurting your credit. Depending on which BNPL company you use, a single late payment can generate a negative report that gets sent to a major credit bureau. Because most BNPL companies don’t default to automated payments, it’s easier than it should be to miss a payment deadline.
- Potential for high interest. In some cases, BNPL companies will charge you more interest than the average credit card.
- Late fees. It’s fairly common for BNPL companies to charge up to 25% of your payment in late fees.
- Spending money unwisely. Clark’s biggest worry when it comes to “buy now, pay later” is overspending. He says the ability to walk out of a store without paying for an item right away encourages people to buy things they wouldn’t otherwise while still creating a financial obligation.
- Complicates your financial life. We’re all busy. Do you really want to add complexity to your life? For example, you can buy an $80 pair of shoes. Or you can finance it through a “buy now, pay later” service. Then you’ll need to remember three $20 payments every two weeks or else risk hurting your credit, paying late fees and paying interest.
Alternatives to ‘Buy Now, Pay Later‘
The best way to make a purchase is to pay in full upfront.
That’s not always true. A mortgage is a good contrarian example. But if you’re buying a $500 piece of furniture because you want to upgrade your apartment balcony, it’s better to pay for it outright than to finance it.
If you’re shopping for something you can’t afford right now, one alternative is to wait until you can.
If you’re going to finance something, paying with a credit card is a strong alternative. The best credit cards offer strong rewards programs. Also, if you’re paying off your credit card at the end of each billing cycle, you won’t have to pay any interest at all. And you’ll make a positive contribution to your credit history.
Final Thoughts
Perhaps you’re a statistical outlier in that you’re not charmed by the ability to walk out of a store with an item, virtually or in person, after paying little to nothing.
Maybe you’re looking at “buy now, pay later” services only from a practical standpoint.
The use cases when it makes sense are extremely narrow. Consider the risk versus reward tradeoff for any BNPL service. Do you really need the item? If so, can you pay for it without financing it? If not, can you use a credit card instead? Do you know the particulars of the BNPL company with which you’re getting into business?
It’s usually a good idea to avoid “buy now, pay later” altogether.
