What is Buy Now, Pay Later?

Chances are you’ve seen it as an option at checkout before: “buy now, pay later”. It’s been reported that 39% of Americans have made a purchase using a “buy now, pay later” plan at least one time. But, what are they, and how do they work? What’s the catch?

Using a “buy now, pay later” service can offer a consumer a chance to make a purchase they might not otherwise be able to afford by spreading out their payment responsibilities over time. However, before you start making these purchases (or continue doing so), it’s important to be fully aware of how they work and understand the potential risks involved.

What is “buy now, pay later”?

A “buy now, pay later” plan (also referred to as BNPL) is a purchase that allows a consumer to use credit to defer their payments, spreading out their purchase over instalments instead of paying all at once like a traditional purchase. Payment plans like these have been available for years with larger-ticket items, such as cars and furniture, but have become an increasingly popular way to finance small purchases as well, particularly those made online.

A BNPL plan requires three different agreements: one between the buyer and the retailer of the goods/services, one between the retailer and the financial service provider and another between the buyer and the financial service provider. In the first agreement, the buyer is promising the retailer that they’ll pay the full price for their purchase (as any standard purchase would work). In the second agreement, the financial service provider pays the retailer up front for the cost of the buyer’s item, less any fees, and agrees to monitor the buyer’s remaining payments according to their payment plan terms. In the third, the buyer pays the financial service provider for the service of breaking up their purchase from the retailer into instalments.

In this case, a financial service provider is the one who’s providing the credit to make the purchase from the retailer. This could be a financial institution (like a bank or a credit union), or it could be a financing company that specializes in BNPL plans, such as Affirm, PayBright or Klarna. Some credit card companies, such as American Express, now offer BNPL as an option for their customers as well. 

How does a BNPL purchase work?

When entering into a BNPL agreement with a financial service provider, they’ll present you with a set of terms and conditions that shape your payment plan. These include your payment amounts, the number of payments you’ll need to make, the frequency of these payments, the interest rate (if there is one), any applicable fees and the payment method you’ll need to use. 

The process of making a BNPL purchase is relatively simple. First, you’ll need to figure out if BNPL is an option for the type of purchase you’re making. If you’re making a purchase online, this is usually advertised as an option when you get to the checkout screen. Second, you’ll need to get confirmation from the financial service provider that you can use their services. This often involves a soft credit check (which does not affect your credit score) and should only take a few seconds. Third, you’ll be asked to pay a down payment on the purchase you’re looking to make (often a small amount, like 25% of the total purchase price). Finally, you pay the remainder of the total purchase price following the payment plan set out by the financial service provider you’ve used. 

The catch here is that it’s crucial you understand the terms of your payment plan before you accept it. The terms of a BNPL agreement may be different between each purchase you make and between different financial service providers, so it’s important to take note of the policy for each purchase you want to make before you confirm. 

How do BNPL companies make money?

Unless you fail to keep up with your payment plan, most BNPL services don’t charge the consumer any interest fees to defer their purchase. But, you may be wondering: if I’m not paying any interest on my purchase, how do BNPL companies make any money? 

In most cases, a BNPL takes a percentage off your purchase price from the retailer as opposed to charging you for their services. This is because statistics show that people generally spend more than they otherwise would when they use BNPL services. Research shows that roughly 55% of consumers spend more using BNPL than they would if they were just making a regular purchase. This larger spend-per-order is a win for retailers, so BNPL companies make a justifiable case in charging them for the purchases consumers make using their services. 

How is BNPL different from using a credit card?

Though a BNPL purchase uses credit to make a purchase, it’s not the same as using a credit card. Your credit card allows you to carry a balance indefinitely - you’ll get charged interest fees for doing so, but there’s no set date that you’re expected to finish paying everything off. With a BNPL, you aren’t subject to the same interest charges as you would be with your card, but there is a clear date upon which you’ll need to have paid off the entire balance of your purchase. 

Another key difference is that when you spend on a credit card, you’re building your credit history and displaying your ability to manage credit. With BNPL, your purchases may not help to build your credit history. However, if you do fail to make payments according to your plan, you will be dinged with consequences that may negatively affect your credit score. 

Finally, most credit cards have generous rewards programs that allow card holders to collect points that can be redeemed for just about anything. These programs can be of immense value to a consumer if used wisely. However, BNPL won’t necessarily offer you the same opportunity to benefit from your purchases beyond their face value depending on how you’re making your payments. 

What should you consider before making a BNPL purchase?

If you’re interested in starting to use BNPL as a tool, it’s important to think about the pros and cons before you get too deeply involved. 

On the pros side, because a BNPL purchase will allow you to defer payments over time, it may allow you to purchase something you want but would otherwise be unable to afford. They also allow consumers to make purchases leveraging credit but without being on the hook for double-digit interest fees, like you would be with a credit card. BNPL purchases are also accessible to people who have low or no credit as they don’t often involve a hard credit check. 

Still, despite the pros column, there are some real risks involved in using BNPL services. Most importantly, there will be consequences for you if you miss a payment or fall behind on your plan. These will range between service providers, but might include late fees, the introduction of an interest rate on your plan or a report to credit bureaus that you’ve fallen behind on payments. This could negatively impact your credit score, making it harder for you to get approved for loans or rentals in the future. 

Another key factor to consider is that BNPL is increasingly used to finance small purchases. For consumers who aren’t careful, small purchases can add up into one big mountain of debt. According to research by C+N, the average consumer with outstanding “buy now, pay later” debt owes $883 and makes payments toward four purchases. Many financial experts are particularly concerned about BNPL and younger consumers, as they don’t often have a high level of financial literacy and may be influenced to overspend when they use the service. 

Beyond that, a BNPL purchase may be harder for you to return. You should eventually get your money back, but you’ll likely need to continue making payments on the plan until you can provide proof that your return has been processed and verified by the retailer. 

Final thoughts on BNPL

Buy now, pay later can be a useful tool in a consumer’s financial routine, but is one that should be used with caution. If you’re interested in starting to use BNPL to make purchases, be sure you understand what you’re committing to before you agree to any payment plan terms. BNPL can help you buy items that otherwise might seem unattainable, but ultimately, it’s important to ask yourself if the purchase is truly worthwhile or if it’s something you’d be better off saving up for.

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