How Does Buy Now Pay Later Work

Written by Robert Ferry on March 25, 2022
How Does Buy Now Pay Later Work

Buy now, pay later (BNPL) is short-term financing that segregates the total purchase amount into installments. The installments must be paid over a certain period, with the first installment due when a person buys the product. BNPL has gained popularity recently, and many individuals seek to benefit from it.

Under the BNPL plan, an individual can enjoy the products by owning them immediately with payment dues in the portion which depends on the plan and financial situation. Some common BNPL plans include weekly, bi-weekly, or monthly payments.

Although the BNPL scheme has existed for a long time as many traditional banks and other financial institutions offer it as a loan, it has become popular only recently. The primary reason is the global pandemic where all the retailers had to shift towards online shopping. As a result, they shifted their marketing strategy by using the BNPL scheme to attract more customers.

Businesses constantly find new ways to bring convenience to their existing customers and attract prospective customers through such schemes. Whether the businesses are operating online or in person, they want their customers to pay their dues without any hassle. Hence, the customers have several options to make the payment which include but are not limited to cash, credit cards, and BNPL.

The BNPL strategy has caused many financial institutions to offer this scheme to their customers in terms of credit cards payments and other debt payments. According to a study by CNBC, the BNPL services by 29% over the year is forecasted to increase further. Similarly, in another study by payments journal, BNPL service is increasing at a rate of 39% in 2022, and it is forecasted to increase further to 42% by 2023.

The article will discuss how Buy Now Pay Later apps work and how to use them. Moreover, we will see how BNPL affects an individual's credit score. We will also discuss the pros and cons of BNPL schemes and/or apps. Lastly, we will highlight the various sites that can be used to access BNPL schemes.

Let us talk about the mechanics of buy now pay later schemes.

How Do Buy Now, Pay Later Apps Work?

At the time of checkout, when you have to make the payment at the time of checkout, you can see that there is a choice that will break your total payment into portions. You will choose to pay a small amount of the total transaction now and move ahead with the BNPL plan. Under this plan, the person is required to make payments. The plan also states that the individual can take the products with them and are not required to make the full payment now.

If the individual finds this scheme interesting, they need to fill out an application to avail the BNPL plan. The application would ask for general information which is specific to each individual. The buy now pays later application would ask you to provide your personal information like your full name, current, and permanent address, date of birth, and phone number. The individual will be asked to choose a payment method for the installments.

After providing all the relevant details, the BNPL provider will carry out a soft pull, which will not cause any adverse effect on the credit score. Based on the result of the soft pull, which will show how your credit history stands, what is your credit score, a decision will be made. That decision will determine if you are good for the BNPL plan. The credit check result will only take a few minutes; hence, the individual will not need to wait long. If you are approved, the BNPL will be activated. If the soft credit check result is bad, the buy application now pays later scheme will be denied.

Although the approval criteria differ from one BNPL provider to another, a person may still be approved if they have a bad credit score. The buy now pays later plan subject to several factors that include the financial situation of the customer and the service offered by the BNPL provider, which can be different.

Many businesses follow the Pay in 4 model provided by the BNPL providers. Under this model, the entire payment is segregated into four equal portions, and each installment has to be paid within two weeks. But the first payment needs to be paid before checking out with the product. This would mean that a person can pay one-quarter of the payment and take home the product under buy now pay later.

The Pay in 4 model does not charge the customers with an interest rate. Hence there are no interest payments. But other BNPL providers do charge interest annually up to 30%. These providers also charge the customers a late fee penalty when the dues are paid late. The late fee is between $7 to $8, usually 25% of the total payment value.

Some famous BNPL providers include PayPal Credit, Afterpay, Affirm, and Klarna (discussed later). Each of these apps works differently, but they have one thing in common. If the individual does not pay their dues in installments before the due date and the interest-free period ends, the payment would incur a heavy interest rate and late payment fee.

We will now look at the impact of the buy now pay later scheme on a person's credit score.

Does Buy Now Pay Later Affect Credit Score?

Buy now pay later is a form of short-term financing where an individual is buying credit from a designated BNPL provider. Buying a credit does not influence the credit score, but how the person uses the credit will directly impact their credit score.

Under the BNPL plan, the individual is purchasing the payment of a product in return for a payment made later. If that individual follows the plan religiously and makes the installments in due time, that will not have any adverse consequences in their credit report. It will help them improve their credit score by showing the lenders that you could be trusted. And that trust comes from assurance and proof that all debts and payments were made promptly. That makes a person a reliable borrower.

Alternatively, if a person does not pay their dues or installments on time, the lenders have no choice but to report this to the major credit bureaus. As a result, the missed payment will become part of the credit report for six years. Hence, the credit score will be adversely impacted, and a decrease in it will reduce the chances of future loans. But the immediate repercussions will be on the current installments that would incur interest payment and late payment fee in addition to the original payment.

So it could be agreed on that if the individual wishes to apply for loans, mortgages, or even credit cards in the future will depend on how they treated the BNPL plan. Hence, the approval for any future credit will be directly proportional to the buy now pay later scheme that the individual has opted for.

Although the buy now pays later plan is tempting and has its perks, opting too much for it on every other transaction can negatively impact the credit score. To understand this, you must be aware that most BNPL providers run a soft check on your credit history when applying. And a soft check does not show in your credit report, so it is a safe option if the lenders go with it.

But there is a probability that a business, BNPL apps, or sites carry out a hard check on your credit report when applying for a buy now pay later plan. This will show on your credit report, which other lenders could see. The consequences extend further as these lenders would believe that the individual is desperate for credit, leading to default payments in the future. These lenders would consider if the person is good to pay their dues on time. And if the credit score is already average, then the BNPL plan will not be offered even after the hard check was carried out.

If the individual keeps on missing the installments under the buy now pay later plan, there are even further consequences. For instance, some businesses will report the unpaid debt to a debt collection agency, which causes more damage to a person's credit score.  

Let us dive into the pros and cons of choosing buy now pay later plan.

Is Buy Now, Pay Later a Good Idea to Make Purchases?

Although the BNPL scheme provides a flexible and convenient way to finance the online shopping experience by creating an easy payment method, several factors must be considered when deciding to go ahead with the buy now pay later plan. Let us consider both the positives and negatives of the BNPL scheme.

Advantages of BNPL

No Hard Credit Check

Most buy now pay later apps will not run a hard check when an account is opened. When a person applies for the BNPL plan, the lenders will carry out a soft check on their account, not impacting the credit report. It is essential to reduce the number of checks on your account because too many checks can adversely impact your credit score.

Interest-free Periods

The buy now pays later is ideal for those that know how to benefit from interest-free periods and clear out their dues before that time ends. Further benefits will link the person's purchase, pay a one-quarter payment, and already own it. Moreover, they don't need to make any interest payments.

Convenient and Efficient

The BNPL plan's convenience is unmatched by any other loan or scheme. People do not need to go on a separate application to provide details or make payments. Moreover, the processing time is swift. The payment options are more or less the same as other BNPL providers.

Zero Interest Plans

Some applications provide a BNPL scheme with no interest link to the payment. This would mean that those applications offer interest-free periods till the last installment is paid. Individuals can opt for such apps and enjoy the perks of not paying any interest payments. But these plans do come with an exception that interest charges will be applicable in the next installment if there is any late payment or missed installment.

No Specific Requirements

The buy now pays later comes with no minimum credit score requirement. Although a soft pull is carried out at the time of account opening, many lenders approve of those individuals with average or low credit scores. Also, the BNPL applications have no other specific requirement, which means anyone can open an account.

Split Payments

People go with the buy now pay later because the total payment is segregated into several installments to be paid overtime. This would make expensive items relatively inexpensive when the payment is to be given in equal portions. As a result, such expenses items become more attainable for someone that cannot pay an influx of cash at once.

Brings Ease of Cash Flow

With a buy now pay later scheme, a person can create a plan that would enable them to buy whatever they are looking for while keeping their budget in view. This payment plan is different for every individual because they all have different purchasing power and budget. Also, the lenders need to consider their financial situation too.

Disadvantages of BNPL

Late Fees

If a person misses an installment under the buy now pay later scheme due to insufficient funds or other reasons (unstated), they will have to incur a late payment penalty. The late fees are fixed just like a penalty the individuals face with credit card payment. But under the BNPL plan, these fees can increase if the installments are continuously paid late. Also, interest charges will be added with the installment payment, increasing the overall purchase payment.

High-Interest Rates

Some BNPL apps have an interest rate as part of the agreement. But these apps do offer interest-free periods, but they are for a limited time. If the person cannot make their dues promptly or within the duration of interest-free periods, they would incur high-interest charges, which would be very expensive. These interest charges can increase over time if the payments are often delayed.

Small credit limits

Each buys now pay later app is different from each others. Some BNPL providers are meant for small-scale purchases. This would mean that an individual cannot buy a product that crosses that limit. Some people have gone on buying expensive products through their BNPL plan. Due to its installment payment not being paid on time, they have paid a lot more than it costs.

Overspending Consequences

The BNPL scheme is very tempting and has resulted in some negative consequences. People do not consider their purchasing power and buy products and services beyond what they could pay for. As a result, they ended up paying late payment fees interest payments, and lenders even updated the credit bureaus of these debts. That brought further damage to their credit score, reducing chances for further loans.

Don't Build credit

The buy now pays later scheme does not help improve the individual's credit score. Suppose a person believes that paying their dues timely would improve their credit score, that is not the case. The BNPL providers do not report to the credit bureaus when a person has paid installment on time. However, they will report to the debt collection agency when debts are left unpaid. However, in the eyes of some lenders paying on time may have positive feedback like reliable borrowers, but that is not for all the BNPL providers. So the probability of that happening is minimal.

Terms May Vary

The BNPL loan scheme will differ for each provider as some may offer an interest-free period for a limited time while others may ask for no interest. Some lenders may also put in the condition of late payment fees and very high-interest charges, which would become costly. And if the product purchased is already expensive, the person would have to pay a large payment as costs and expenses.

We will now discuss the different buy now pay later apps offered in the financial industry.

Popular Buy Now Pay Later Apps

There are several buy now pay later providers in the market that businesses use. Each business more or less uses the following BNPL apps:

PayPal Credit

PayPal Credit, known as Bill Me Later service, is acceptable at any business, store, etc., that accepts PayPal. Most businesses consider using this BNPL plan and offer it to their clients. This is a credit line, and its use is very similar to any credit card; hence it can be used time after time until the credit limit is reached.

The lender charges a very high APR rate of 23.99% if full payment is not written off in the interest-free period. The interest-free period for PayPal credit is about six months since the opening of the account. But to avail of it, the person has to make a minimum purchase of $99 or higher. All purchases under the $99 limit will not incur interest charges and can be paid in installments. But payments higher than $99 will be prone to the interest rate if not paid off in six months.

PayPal credit is linked with deferred interest, which means the interest rate will increase in the case of default payment. And by the end of six months, a high interest will be charged on the total amount, which will go back to the original amount of the product. Synchrony Bank issues PayPal credit, and they are going to carry out a hard check before approving the BNPL plan.

Afterpay

Afterpay is one of the largest BNPL providers that allow customers to pay back the purchase amount in three or four installments. Generally, the lender follows the Pay in 4 model with the first payment due at checkout. The payment agreement consists of an upfront deposit that accounts for the first installment and future installments to be paid in two weeks for each installment.

Afterpay does not charge its clients any interest rate even when they make payments past the due date. But the lender charges a late deposit fee, which is reported to the credit bureaus and adds to hurt the credit score. The late payment fee is $8, fixed for all the clients. Typically, the late fees are 25% of the purchase amount, but the company asks for a fixed payment from the customers.

The app is perfect for people who require a set plan for the BNPL scheme. Afterpay also sets up the maximum credit limit that the person is entitled to spend and payback. If a person defaults on the installment, the lender will charge the total amount on the linked card that the client is obligated to pay.

Affirm

Affirm has partnered with several famous retailers that include Walmart, Adidas, Pottery Barn, Expedia, etc., so individuals can opt for the BNPL plan at these businesses. The interest rates are different for each retailer; hence the repayment and interest rate will differ for each retailer. Depending on where you shop, the interest fluctuates from as low as 0% to as high as 30%. The repayment period can go from 6 months to 1.5 years.

Affirm will provide you with the interest rate figure that a person will be charged when signing the contract. The interest rate is directly proportional to the creditworthiness of an individual. The lender does not charge for delayed payments, meaning no late fees will be. Affirm does not ask for prepayment fees nor demands for deferred interest charges.

The buy now pays later scheme at Affirm directly impacts the credit score, so if a person makes payments promptly, that will positively impact the credit score. However, if a person defaults, the credit score will be adversely impacted. If a person wishes to purchase with a BNPL scheme but Affirm is not partnered with that business, the lender will provide the customer with a virtual card number. That number will be used to purchase and make repayments according to the payment plan selected by the client. 

Klarna

With Klarna, the total purchase amount is divided into four installments which should be paid back every two weeks. The first installment will be charged at checkout, accounting for a quarter of the total amount. The app is very restricted to the payment schedule set for each individual. So if the payment plan is followed and the required amount is written off within the due date, no late fees or interest charges will be added. If a person defaults and cannot pay the installment, there will be a penalty for late fees and interest charges.

As part of the agreement signed with Klarna for the BNPL plan, the lender is obligated to charge the full amount to the card linked with the plan. As a result, the customer has to pay the amount they owe to the lender. The lender will also report this activity to the credit bureaus, further damaging an individual's credit score.

Klarna is partnered with some well-known brands, including Sephora, Foot locker, Macy's, etc., with a vast customer base. Customers who shop at these brands can avail of the buy now pay later plan with Klarna as their loan provider.

Klarna follows the Pay in 4 model and will not charge its clients any interest, but if the customers fail to pay the due amount twice under one BNPL plan, they will have to pay a late fee of $7. 

Other Buy Now Pay Later Apps

There are several other BNPL companies out there that are offering their services to clients seeking this specific plan to make purchases. The apps are easy to use, and their accessibility attracts many people to avail of the services.

With BNPL sites, purchasing products has become very easy, bringing simplicity. Some other buy now pay later apps would include the following:

Conclusion

The buy now pay later scheme is tempting as it paves the way for convenience and efficiency. People can make payments for expensive products in installments instead of upfront. Some BNPL apps offer an interest-free period, and people can take advantage of it by paying all their dues before it ends.

Moreover, you can even avoid interest payments by paying dues in time. Other BNPL apps do not ask for any interest but have strict rules in terms of late payments. It is wise to pay all dues before the due time comes to an end to avoid any financial inconvenience.

It is crucial to evaluate if you can make the payments as agreed in the installment. If you cannot do that, it is advised not to go ahead with the plan. Since the plan's name is "buy now, pay later," you are entitled to pay later. That is why a person should do the math and see if they could afford to pay afterward. If they can, then BNPL is a good enough plan.

Article written by Robert Ferry
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