Since the beginning of the pandemic, the “buy now, pay later” option has rapidly grown in popularity, especially among younger and low-income consumers who do not have ready access to traditional credit.
If you’ve been shopping online for clothing or furniture, sneakers, or concert tickets, you’ve seen the option to split the cost into smaller installments over time at checkout. Companies like Afterpay, Affirm, Klarna, and Paypal are offering the service as Apple hits the market this year.
But as economic instability increases, so does crime. A report by the Consumer Financial Protection Bureau (CFPB) on Thursday reveals consumer risks associated with buy now, pay later plans—a market that is mostly unregulated and lacks many of the same protections provided by other credit lenders.
“Buy now, pay later products have become a convenient way for consumers to delay payments and manage their spending, but these loans come with hidden risks,” said Delicia Hand, director of financial justice at Consumer Reports.
“Consumers can face unexpected costs and frustration when they fall behind on payments or disagree over an unwanted or fraudulent purchase,” he added. “The CFPB’s report makes clear that new rules are needed to treat consumers who rely on buy now, pay later plans fairly and receive the same protections guaranteed by other types of loans.”
Here’s what you need to know about BNPL plans before accepting them.
How does buy now pay later work?
Buy now, pay later services, called “interest-free loans,” require you to download an app, connect a bank account or debit or credit card, and sign up to pay in weekly or monthly installments. Some companies, such as Klarna and Afterpay, do soft credit checks that are not reported to credit bureaus before approving borrowers. Most are confirmed within minutes. Scheduled payments are then automatically deducted from your account or charged to your card.
Services usually don’t charge more than you pay upfront, so there’s technically no interest as long as you make the payments on time.
However, if you pay late, you may incur a flat fee or a fee calculated as a percentage of your total debt. These can go up to $34 plus interest. If you miss more than one payment, you may stop using the service in the future and the guilt may hurt your credit score.
Are my purchases protected?
In the US, buy now pay later services are not currently covered by the Lending Truth Act, which regulates credit cards and other types of loans (those repaid in more than four installments).
This means it can be more difficult to resolve disputes with sellers, return products or get your money back in cases of fraud. Corporations can provide protection, but it is not mandatory.
Lauren Saunders, assistant director at the National Center for Consumer Law, advises borrowers to avoid connecting a credit card to buy now and pay later applications whenever possible. If you do, you lose the protections you get from using the credit card, and you also open yourself up to interest in the card company.
“Use the credit card directly and get these protections,” he said. “Otherwise, it’s the worst of both worlds.”
What are the other risks?
Buy now, pay later because there is no centralized reporting, these debts won’t necessarily show up on your credit profile from major credit rating agencies.
This means that more companies may allow you to buy more products even if you can’t afford them, because lenders don’t know how much credit you have with other companies.
Payments you make on time are not reported to credit rating agencies, but underpayments are reported.
“Right now, buy now, pay later usually won’t help you build credit, but it can hurt,” Saunders said.
Elyse Hicks, consumer policy advisor to Americans for Financial Reform, a progressive nonprofit, said people may not take seriously enough whether they can afford to pay at the end of the road.
“Because of inflation, people may think, ‘I’m going to have to buy what I need and pay in those installments later,'” he said. “But six months from now can you still afford what you can afford now?”
Why do retailers offer buy now pay later?
Retailers accept backend fees for buy now, pay later because products increase cart sizes. When shoppers are given the option to shop in installments, they are more likely to purchase more items at once.
When Apple recently announced it would be creating its own buy-now-pay-late service, 23-year-old Josiah Herndon joked on Twitter about “paying for 6 shopping carts I couldn’t afford with Apple, Klarna, Afterpay, PayPal Pay in.” 4, Pay at 4 and Confirm.”
Herndon, who works in insurance in Indianapolis, said that he started using the services because his credit card took a long time to be approved, because his age does not have an extensive credit history. He has since used them to pay for high-end clothing, shoes, and other luxury goods. Herndon said he aligned his payment plans with paychecks to avoid missing out on installments, describing the option as “very convenient.”
Who should use buy now pay later?
Buy now, pay later loans are a relatively healthy, interest-free form of consumer loan if you can make all payments on time.
“If[the loans]work as promised and people can avoid late fees and have no trouble managing their finances, they have a place,” said Saunders of the National Center for Consumer Law.
But if you want to improve your credit score and you can make your payments on time, a credit card is the better choice. The same is true if you want strong legal protections against fraud and clear, centralized reporting of loans.
If you’re not sure whether you can make payments on time, consider whether the fees charged by buy now, pay later companies could generate higher fees than the penalties and interest that a credit card company or other lender would charge.
How does economic instability affect buy now pay later?
aspectSome customers have started splitting payments for essentials rather than big tickets like electronics or designer clothing. A survey released this week by Morning Consult found that buy now pay later customers use the service for routine purchases like groceries and gas, ringing alarm bells among financial advisors.
Hicks points to the growing number of late payments as a sign that buy now, pay later may already be contributing to unmanageable debts for consumers. A July report by the Fitch rating agency found that in the 12 months ended March 31, app defaults rose sharply as much as 4.1% for Afterpay, while credit card defaults remained relatively flat at 1.4%.
“The growing popularity of this will be interesting to see these different economic waves,” Hicks said. Said. “Sudden fallout is what’s happening right now.”
The Associated Press receives support from the Charles Schwab Foundation for education and explanatory reporting to improve financial literacy. The independent foundation, Charles Schwab and Co. Inc. is separate.