What is buy now, pay later and how does it work?

Buy now, pay later has seen a huge explosion in popularity in recent years, allowing millions of shoppers to use companies such as Klarna and Clearpay to break down the cost of purchases into smaller amounts.

The trend shows no signs of letting up, with NatWest set to become the first major UK bank to enter the buy now, pay later (BNPL) market when it launches a product this summer.

Meanwhile, Apple is planning a BNPL service as part of its new operating system, iOS 16, for US users.

However, the industry has come under fire, with warnings that many shoppers don’t understand the risks, whether it’s racking up late payment fees or getting a black mark on your credit score. If you take steps to improve your credit scoreit could be a blow.

Worryingly, two-fifths of BNPL clients have borrowed money to make repayments, according to research by Citizens Advice (opens in a new tab). Buyers used credit cards, overdrafts and even payday loans to pay for their purchases. Stacking loans on top of loans is never a good idea and can be a fast track to getting into debt.

Myron Jobson (opens in a new tab), senior personal finance analyst at investment platform Interactive Investor, said: “The escalating cost of living crisis may have people turning to BNPL programs to help them get by. Taking out a loan to pay back buy now pay later could lead to a perpetual cycle of debt that is hard to escape.

Here we explain what BNPL is, how it works and the risks that all buyers should be aware of.

What is buy now, pay later?

Buy now, pay later is a form of borrowing that allows buyers to delay paying for their purchases. Instead of paying at the checkout or online checkout, the BNPL provider pays the merchant for you. You then reimburse the supplier over several weeks or months. There is normally no interest or fees to pay, as long as you make the repayments on time.

Suppliers include:

The largest provider, Klarna, has 16 million customers in the UK.

From clothing and beauty to household goods and toys, thousands of retailers accept BNPL and retailers tend to work with specific BNPL suppliers. For instance, Marks & Spencer (opens in a new tab) works with Clearpay, while Klarna has partnerships with many retailers, including asos (opens in a new tab), Expedia (opens in a new tab) and Nike (opens in a new tab). Other retailers that accept BNPL payments include Ikea (opens in a new tab), Adidas (opens in a new tab), JD Sports (opens in a new tab) and Wayfair (opens in a new tab). Klarna and Clearpay also have their own shopping apps.

Buyers can usually choose from several payment options. For example, you can spread the cost over multiple installments. The first payment is made when the item is purchased, with the remaining installments scheduled over the coming weeks or months. Or you can avoid paying anything on the day of purchase and pay the full balance later.

How is the BNPL different from a credit card?

Buy now, pay later differs from a credit card because there is usually no interest or fees to pay. However, you must make the payments at the agreed time, otherwise you will be charged late fees.

There’s also no physical plastic card to use, like with a credit card. Instead, the borrowing method is applied virtually: you shop through a BNPL website or app, or select the option at a retailer’s checkout.

With a credit card, interest is charged (unless you’re on a 0% promotional period) and customers must pay the minimum balance each month.

Previously, another point of difference was that BNPL generally did not affect your credit score. However, providers are now increasingly working with credit reference agencies. Klarna sends information about purchases paid on time, late payments and unpaid purchases to Experian (opens in a new tab) and Trans Union (opens in a new tab). Laybuy sends data to Experian and Congratulations to the credit (opens in a new tab)while PayPal reports data from its Pay in 3 customers to credit reference agencies.

How do BNPL companies make money?

Instead of charging the customer, BNPL suppliers take a cut from the retailer. This is usually a small percentage of each sale, like 5%. They argue that BNPL is a popular option for shoppers and can significantly boost retailer sales. Suppliers can also make money from late fees, when customers don’t pay on time.

While the BNPL industry is currently unregulated – it will hopefully be regulated later this year – the financial watchdog has taken a close look at how providers operate.

Earlier this year, the Financial Conduct Authority found some of the late payment fee rules to be unfair and called on Clearpay, Laybuy and Openpay to refund customers who had been hit with penalties despite canceling their payments completely. online orders.

Will the use of buy now, pay later affect my credit rating?

Using buy now, pay later could affect your credit score – especially now that BNPL providers increasingly work with credit reference agencies. If you have a good track record of paying on time, it could boost your score and give you a better grade. If you make late payments — or miss them — it could hurt your credit score. However, it depends on the BNPL provider you are using.

Laybuy’s reports to credit agencies impact credit ratings. He said: “We think it’s important for other credit providers to have visibility into a person’s credit history, both good and bad, so they can make informed credit decisions.

“Making timely repayments will help improve a person’s credit rating, making it easier for them to open credit (such as utility accounts) on more favorable terms, while reporting a negative credit history will see a person’s credit rating decrease and it reduces the risk of credit being extended to someone who cannot afford it”.

However, with Klarna and PayPal, although the transactions become part of someone’s credit report, they still won’t impact credit scores. It could happen later in 2022.

Clearpay does not report purchases to credit reporting agencies, but said it was “reviewing its approach to credit checks and recognizing that credit reports can add value for customers.”

What if I can’t afford to pay?

BNPL refunds are normally taken automatically from your bank or building society account. If there is not enough money in your account, you may be charged late fees.

These fees range from £6 to £12 – although Klarna and Paypal do not charge late fees.

Depending on the supplier, the fee may be capped at a certain level, such as 25% of the order cost. Remember that you may be charged several late fees for each order. Missed payments can also hurt your credit score.

If you know you can’t afford to pay and are going to miss a payment, the important thing is to contact the BNPL provider in advance. They may be able to give you more time to pay or help you work out a repayment plan.

It can be very tempting to use BNPL for more purchases, but try to avoid using it again until you are sure you can afford the refunds.

Advantages and disadvantages of buy now, pay later

Advantages

  • It’s an easier way to borrow money than applying for a credit card, overdraft or loan
  • It’s fast and convenient – just apply as part of the purchase transaction
  • You have more time to repay the full cost than using a debit card, which could help you manage your cash flow, especially during the cost of living crisis.

The inconvenients

  • It can be tempting to overspend if you don’t have to pay for groceries right away. Sarah Coles, senior personal finance analyst at wealth manager Hargreaves Lansdown, said: “Apple’s decision to buy now, pay later could fuel another market boom, exposing more buyers to the risk of overspending.”
  • Using BNPL can also become a habit, potentially affecting your future finances.
  • If you can’t repay, you could incur late fees and it could impact your credit score
  • A 0% credit card or 0% overdraft might be a better option, and they’re regulated, giving you valuable protection, like the ability to complain to the Financial Ombudsman Service if something goes wrong.

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