Buy now, pay later (BNPL) services from companies like Affirm, Klarna and Afterpay are the latest online shopping innovation to go mainstream, and they’re only growing in popularity. How you use these services may also affect your credit score very soon, if it's not already happening.
BNPL usage during the Cyber Week (November 23-29) in 2021 was up 29% from the previous year, according to data from Salesforce, with more than $22 billion worth of purchases financed globally.
BNPL plans (sometimes called point-of-sale loans) let consumers pay for purchases in interest-free installments over a short period of time, usually about four weeks. Some BNPL companies also offer longer-term financing for larger purchases.
Essentially, BNPL plans are a modern-day cross between traditional credit cards and old-school layaway programs: They allow consumers instant access to a purchase without paying the full price upfront.
Shoppers can apply for the financing at checkout with online retailers like Walmart and Ulta Beauty and be approved for a short-term loan almost instantly, often (but not always) after a soft credit check that doesn't impact a credit score. The services are especially popular among Gen Z and millennials, who make up roughly 60% of applicants according to a recent TransUnion study. They are most frequently used for sub-$500 purchases like clothing, electronics and home goods, CreditKarma found.
While short-term BNPL data was not widely reported to the major credit bureaus when the services were first introduced, that's changing. And the changes could affect your credit score if you’re a frequent user of Affirm, Klarna or another similar service.
Credit scores are used by lenders to determine your creditworthiness for a range of products, from mortgages to student loans to home equity lines of credit and credit cards. The higher your score, the more likely you are to receive favorable loan terms like lower interest rates. A history of timely bill and credit card payments will raise your score, while late payments and using too much of your available credit will lower it.
How buy now, pay later services affect credit scores
In December, Equifax, one of the three major credit reporting agencies, announced that it had developed a formal process for BNPL companies to report short-term loan data to be included on its credit reports. While BNPL providers are not required to report data to credit bureaus, Equifax says it anticipates that its new policy will encourage more to do so. The company plans to begin implementing that process at the end of February.
Experian, another credit reporting agency, said it has worked with BNPL providers since 2016 and is in the process of adding more data to credit reports "in a way that will ensure the responsible use of BNPL products does not negatively impact consumer credit scores.”
Liz Pagel, senior vice president and consumer lending business leader at credit reporting agency TransUnion, said the company believes that reporting BNPL data “will provide a more complete picture of a borrower and promotes financial inclusion.” She added that TransUnion is “well on our way” to including the data in credit reports.
Young consumers have the most to gain
Because younger consumers have had less time than their older counterparts to build a solid credit history, they likely have the most to gain from the upcoming changes at the major credit bureaus. Building up a track record of on-time payments is one of the best ways to bolster your credit score, and short-term BNPL loans allow consumers who might not have access to other forms a credit a way to establish this good history.
Equifax cited a study of BNPL data showing that on average, customers who paid their loans on time would benefit from including that data in a credit report — the average FICO score bump was 13 points. People with thin or young credit files saw an average FICO score bump of 21 points.
Of course, the other side of the coin is that using these services irresponsibly can hurt your score. More on that below.
When buy now, pay later hurts credit scores
While they have a lot of benefits — convenience, no interest terms and the potential to boost your credit — there are real dangers to using BNPL plans. For one thing, it’s possible to rack up major fees and interest charges if you don’t pay off your balance on time. Last month, the Consumer Financial Protection Bureau announced a probe into five major BNPL companies, prompted by concerns that the services are allowing consumers to accrue too much debt.
With credit bureaus on their way to using BNPL data, the risks are even higher. If your BNPL provider reports a late payment to credit bureaus or if your balance is sent to collections, your credit score may take a hit.
That means a misstep with a BNPL payment plan could have a ripple effect that sets your credit back for years: Think higher interest rates, higher premium payments and more difficulty qualifying for loans.
The bottom line? Now more than ever, don’t use one of these services for anything you can’t afford to pay for in full.