While shopping online, you may have noticed “buy now, pay later” purchase options that break up the cost of an item into interest-free installments. It’s sometimes called “digital layaway,” except that your item is shipped to you right away—what’s not to like? Well, these loans can make shopping a little too easy, and the late fees, should you default on your payments, can be surprisingly steep, even for low-cost items.
How does it work?
As the pandemic has led to a spike in online shopping, the “buy now, pay later” (BNPL) trend has only grown in popularity, particularly amongst millennials, who have embraced debit spending as an alternative to credit cards (18% of millennials have made at least one BNPL purchase over the past two years).
The setup is pretty simple: As you shop for an item like a Peloton bike or an Anthropologie dress, you will be offered a point-of-sale loan from a BNPL company as a payment option (as an example, you buy something for $1,000, you may have the option to pay that amount in $250 installments over four months). Companies like Afterpay , Affirm, and Klarna will service your loan, and they don’t require a hard credit check or charge interest on what is essentially a personal loan.
To make money, buy-now-pay-later services charge merchants and retailers a fee of 4-6% per transaction—twice as much as what a credit card company typically charges. In exchange, retailers (Urban Outfitters, Walmart, Anthropologie, and Warby Parker among them) earn additional revenue overall by increased sales of big ticket items customers might not otherwise purchase, especially shoppers with low-limit credit cards or low credit scores.
So what’s the problem?
Sarah Newcomb, director of behavioral science at Morningstar, described it best in an interview with The Atlantic:
“What may be predatory to one type of customer is actually a very good solution for another type of customer.”
What’s enticing about these services (“no credit check required!”) is also what makes them a bit dangerous. The loans are easier to qualify for than credit cards, but consider that credit cards are already debt traps for many people; installment loans carry similar risk (a recent Cardify.ai survey reveals that 62% of BNPL users have unpaid balances totaling more than 75% of their total credit limit when signing up for installment payments). On the other hand, the same study reveals that 50% of users have enough money to pay for their purchase five times over, so it’s really a mix of people using BNPL, with some spending more responsibly than others.
And then there’s the matter of late fees, which can range from $7 to $10 per missed installment. That might not sound like much, but it can be expensive in relation to the cost of the items, especially when the purchases are small—say, $100. These services typically won’t help you build your credit score, either, but they can certainly damage it if you miss a payment. And despite the fact that most of these services are known for offering zero-interest loans, some actually do charge interest depending on your payment plan—you’ll want to read the fine print before signing up.
BNPL services can be a good alternative to using a credit card, but they shouldn’t preclude any legitimate reasons you might have for not using a credit card, too. If your credit card is maxed out or impulse shopping is an issue for you, the temptation might not be worth the bother—it might be easier to simply stick to saving up for a purchase. And kicking payments down the road can catch you off guard later: A recent Cornerstone Advisors study revealed that 43% of buy-now-pay-later consumers have missed a payment, with two-thirds of those respondents blaming it on losing track of when the bill was due, rather than being short of cash.