As consumers prepare for their holiday shopping this year, some may turn to “buy now, pay later” loans to finance gift purchases, especially young and low-income consumers who may not have easy access to traditional credit.
But financial experts caution buyers to be aware of the hidden financial risks of these popular loans. If you’ve shopped online for clothing or furniture, sneakers or concert tickets, you’ve likely seen the option at checkout to split the cost into smaller installments over time. companies like postpaid, Say, klarna Y PayPal all offer the service, and Apple is due to enter the market later this year.
But with increasing economic instability, so do delinquencies. a september report released by the Consumer Financial Protection Bureau (CFPB) reveals the consumer risks involved in Buy Now Pay Later (BNPL) plans, a market that is largely unregulated and lacks many of the same protections provided by other forms of credit loans.
Risk of overspending
“One of the biggest risks of buying now, paying later at the holidays is spending too much,” Annie Millerbernd, personal loan expert at NerdWallet, said in an email. “A recent NerdWallet study found that consumers who used BNPL in the past year did so an average of six times.”
It can be difficult to keep up with multiple BNPL loans, experts said. Millerbernd recommends using BNPL for a single gift or at a retailer, then paying off that loan before taking out another.
And shoppers using BNPL loans typically spend 10-40% more when paying with these loans than with a credit card. according to to new research from researchers at Harvard Business School. Because loans break a purchase into smaller installments, it can tempt buyers to buy more expensive items.
Here’s what you need to know about BNPL plans before you agree to them.
How does buy now, pay later work?
Branded “interest-free loans,” buy now, pay later services require you to download an app, link a bank account or a debit or credit card, and sign up to pay in weekly or monthly installments. Some companies, like Klarna and Afterpay, run soft credit checks, which are not reported to credit bureaus, before approving borrowers. Most are approved in minutes. Scheduled payments are automatically deducted from your account or charged to your card.
The services generally don’t charge you more than you would have paid up front, which means there’s technically no interest, as long as you make payments on time.
But if you pay late, you may be subject to a flat fee or a fee calculated as a percentage of the total you owe. These can cost up to $34 plus interest. If you miss multiple payments, you may not be able to use the service in the future and late payments could affect your credit score.
Are my purchases protected?
In the US, buy now, pay later services are not currently covered by the Truth in Lending Act, which regulates credit cards and other types of loans (those paid in more than four installments). .
That means it might be harder for you to resolve disputes with merchants, return items, or get your money back in fraud cases. Companies can offer protections, but are not required to.
Lauren Saunders, associate director of the National Center for Consumer Law, advises borrowers to avoid linking a credit card to buy now, pay later applications whenever possible. If you do, you lose the protections you get when using your credit card and, at the same time, you risk owing interest to the card company.
“Use the credit card directly and get those protections,” he said. “Otherwise, it’s the worst of both worlds.”
What are the other risks?
Because there’s no centralized buy-now-pay-later report, those debts won’t necessarily show up on your credit profile with the major credit rating agencies.
That means more businesses may let you buy more items, even if you can’t afford them, because lenders don’t know how many loans you’ve set up with other businesses.
Payments you make on time are not reported to credit rating agencies, but late payments are.
“Right now, buy now, pay later usually can’t help you build credit, but it can be detrimental,” Saunders said.
Elyse Hicks, consumer policy adviser for Americans for Financial Reform, a progressive nonprofit, said people may not seriously enough consider whether they will still be able to afford payments in the future.
“Because of inflation, people may think, ‘I’m going to have to get what I need and pay for it later in these terms,'” he said. “But are you still going to be able to pay for the things you’re paying for now six months from now?”
Why do retailers offer BNPL loans?
Retailers accept backend buy now, pay later fees because products increase cart sizes. When shoppers are given the option to pay for purchases in installments, they are more likely to purchase more products at one time.
When Apple recently announced that it will create its own Buy Now, Pay Later service, Josiah Herndon, 23, joked on Twitter about “paying for 6 carts of (things) I can’t afford with Apple, Klarna, Afterpay, PayPal Pay in 4, buy, pay in 4 and affirm”.
Herndon, who works in insurance in Indianapolis, said he started using the services because it was taking a long time to get approved for a credit card, as his age meant he didn’t have an extensive credit history. Since then, he has used them to pay for high-end clothing, shoes and other luxury items. Herndon said he aligns pay schedules with his paychecks so he doesn’t miss dues, calling the option “very convenient.”
Who should use buy now pay later?
If you have the ability to make all payments on time, buy now, pay later, loans are a relatively healthy, interest-free form of consumer credit.
“If (the loans) work as promised, and if people can avoid late fees and don’t have trouble managing their finances, they have a place,” said Saunders, of the National Center for Consumer Law.
But if you’re looking to boost your credit score and can make payments on time, a credit card is a better option. The same is true if you want strong legal protections against fraud and clear, centralized loan reporting.
If you’re not sure whether you’ll be able to make your payments on time, consider whether the fees charged by Buy Now, Pay Later companies will add up to higher charges than the penalties and interest a credit card company or other lender would charge.
How will economic instability affect buy now, pay later?
As the, some shoppers have begun splitting payments on essential items, rather than just big-ticket items like electronics or designer clothes. A Morning Consult survey published this week found that 15% of shop-now-pay-later customers use the service for routine purchases like groceries and gas, ringing alarm bells among financial advisers.
Hicks points to the growing number of late payments as a sign that buy now and pay later could already be contributing to unmanageable debt for consumers. A July report from ratings agency Fitch found that app delinquencies rose sharply in the 12 months ended March 31, up 4.1% for Afterpay, while credit card delinquencies flattened. relatively stable at 1.4%.
“It will be interesting to see the growing popularity of this in these different economic waves,” Hicks said. “The immediate consequence is what is happening now.”
The Associated Press receives support from the Charles Schwab Foundation for educational and explanatory reporting to improve financial literacy. The independent foundation is separate from Charles Schwab and Co. Inc.