Understanding the risks of buy now, pay later apps

Spending money you don’t have has become easier than ever before.

Buy now, pay later (BNPL) services have been on the rise for years, with companies such as Klarna, Zip, and Afterpay offering zero-interest payment plans for a variety of purchases from partner retailers — everything from mattresses to electronics, sporting goods, clothing, jewelry and more. Their apps are marketplaces full of major retail brands that beckon you with deals and offers, and the clincher: You don’t have to pay for the whole purchase now.

Apple already offers zero-interest payment plans on its products through Apple Card, but the company is adding a new BNPL option called Apple Pay Later that will be connected to Apple Wallet. Now, with an iPhone’s wireless tap, users can purchase non-Apple products spread out in four payments over the course of six weeks.

Tempting, right? That’s the point.

A whopping 43 percent of Americans said they have used a BNPL service, according to an April 2022 LendingTree poll, up from 31 percent in 2021. These services are also most popular among women, Gen Z (ages 18 to 25), and those making between $50,000 and $74,999 a year.

More from College Voices:
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College students and recent graduates, who make up Gen Z, tend to have little to no credit history and are generally less financially literate. If mismanaged or overused, BNPL services can lead to drastic consequences on a young consumer’s already delicate financial wellness.

“As it becomes easier for consumers to access buy now, pay later loans, it becomes more important for the consumer to be their own filter and to go through all the right steps that they need to take to ensure that they are borrowing for the right reasons,” said Bruce McClary, senior vice president of membership and communications at the National Foundation for Credit Counseling.

Without understanding the hidden risks of BNPL loans, these services can cause consumers more harm than good. Here’s what you need to know before considering using BNPL apps.

When to use a BNPL app

Carefully review your personal finances before signing up to ensure the BNPL loan won’t saddle you with debt you can’t pay back.

“It’s important to know your financial situation and capacity for managing multiple types of loans before you jump into these things,” said Matt Schulz, chief credit analyst at LendingTree.

The first questions you need to ask yourself are:

1) Is the purchase necessary/one you won’t regret?

2) Is buy now, pay later the only way you can afford it?

3) Are you certain that you can and will make the payments on time?

Generally speaking, it’s better to pay off purchases in full and not have a loan hanging over your head. It’s easier, less risky, and more financially responsible.

“If you have the money, if you can afford it, and if it’s not going to derail your budget, go ahead and just pay the balance,” McClary said. “It’s certainly less complicated than entering into some kind of a multipart payment plan.”

If it’s a necessary purchase — say a new mattress or a new computer — and you know that you will be able to make the monthly payments (make sure you know what they are before you buy the item) then a buy now, pay later loan might be a good option for you.

You should try avoid using BNPL to finance superfluous purchases that you cannot afford and do not need. For instance, if that designer bag you’ve always wanted is only within reach by means of going into debt, you might want to rethink that purchase.

“It just encourages you to buy things that you previously wouldn’t have been able to buy,” said Maddie White, a fashion influencer with over 2.6 million followers on TikTok and outspoken skeptic of BNPL. “Even though you made it happen, it’s not necessarily a financially responsible decision.”

And, consider this: An emergency expense — like a new mattress or computer — could pop up that can’t wait. What happens if you can’t afford it because you’re still paying off that handbag? Or, maybe you qualify for a second buy now, pay later loan, but then you have two giant bills hanging over your head for the next year or however long?

To take it one step further: What happens if you have all that outstanding debt and then you lose your job? You see where racking up too much debt can be a slippery slope. The hidden risks of these loans might cause unnecessary harm to your financial wellness. If you have to take one out, you want to know that it’s manageable.

If you miss a BNPL payment, what will happen?

Of course, no one anticipates they would miss a payment when they opt into a BNPL service. 

It happens more often than you might think. Forty-two percent of consumers who have used a BNPL service have made at least one late payment, according to LendingTree.

When you sign up for that loan — and remember, it IS a loan, not just a purchase — it’s important to understand what will happen if you forget to make a payment.

“Even though you may think that you’re not going to get off track, you need to be prepared in case you do need to understand the consequences that you might face,” McClary said.

Most BNPL services charge a late fee or start charging interest on late payments.

Afterpay says it will pause your account and not allow you to buy anything else until you are caught up on your payments. And, missing a payment might impact your spending limit.

So, make sure you read the fine print of the BNPL service you might use before opting in.

You should know if your BNPL activity will be shared with credit bureaus, which impacts your FICO credit score. Unlike credit cards, not all BNPL loan payments are reported to credit bureaus. However, different BNPL services — and even different loans within these services — have different rules about reporting payments.

Sometimes, only late BNPL payments are reported, which might negatively affect your credit score. This can have a drastic impact on your prospects of applying for a credit card, mortgage rates and other loans.

“When it comes to credit, it’s mostly downside and not a whole lot of upside,” Schulz said. “These lenders aren’t typically reporting good credit history, but if you make a late payment, some lenders will report that. A single late payment can really do some damage to your credit report.”

With the increasing use of BNPL loans, some credit reporting agencies are making efforts to gather as much data as possible on these loans. Experian and TransUnion have already announced plans to include BNPL loan data in consumers’ credit scores.

As a young consumer with little credit history, you don’t want these late payments to ding your credit score.

“It’s entirely possible that there are young folks out there that may not have anything else on their credit report other than a late payment on a buy now, pay later loan,” Schulz said. “It’s tough to start building your credit from there.”

Does spending with BNPL feel too easy?

If going on shopping sprees or making large purchases feels easier than usual when using a BNPL service, you might need to do a double-take and ask yourself: Are you overspending?

One of the primary financial risks of BNPL is that it may encourage you to spend significantly more than you normally would. Almost 70% of consumers that have used BNPL services admit to overspending when using them.

“With these loans, overspending is kind of the point,” Schulz said. “It’s important for people to understand that just because someone will give you money, it doesn’t mean that you should take it or can afford it.”

Social media platforms such as TikTok and Instagram motivate overspending by amplifying the pressure for users to subscribe to fast fashion and other trends. White attributes viral trends to the uptick in BNPL use among young consumers.

“Social media contributes to how quickly the trend cycle returns, and then when the trend cycle overturns, that encourages people to buy more things,” White said.

A lot of these Buy Now, Pay Later marketplaces egg you on with their marketing on social media platforms, showing you how much you can buy now and pay for later. This relentless messaging, coupled with virtually unfettered access to BNPL loans, can make overspending alarmingly easy.

“Anybody with the right technology and account access can start in minutes and get the financing they want, whether they can afford to pay it or not,” McClary said. “Imagine how much debt you can run up in a matter of 30 minutes. It’s astounding.”

Keeping close tabs on your BNPL loans is key to resisting overspending. If BNPL users don’t budget these payments into their finances, it can lead to a silent accumulation of debt. “They ordered five things in the same week and all of a sudden, a month down the line, they’ve got six payments and they can’t afford it,” White said.

“It’s not like opening your wallet and taking your cash out and saying ‘Oh, I only have X dollars left,'” said Carrie Rattle, CEO of Behavioral Cents and a financial therapist who specializes in compulsive spending. “If financial literacy is not in the picture of the person who’s actually purchasing, and they’re not adding up all those payments they’re going to owe in 15 days, they go into debt.”

Despite the risks that come with BNPL, Rattle says these services and their small point-of-sale loans can help young consumers build their financial literacy when used correctly. Rattle points out that two core competencies of saving money are discipline and planning ahead — two qualities that are vital to keeping up with BNPL payments.

“If you adhere to buy now, pay later, and actually pay on time, you’re good at both of those already,” Rattle said. “In that way, if you can manage it, BNPL trains you for excellent money behaviors.”

Do you know the changing rules and regulations?

Because BNPL apps are still relatively new to the fintech market, the rules for credit reporting and regulation are constantly changing. The Consumer Financial Protection Bureau launched an inquiry in December 2021 into BNPL services amid growing pressure to regulate them.

“The CFPB is concerned about accumulating debt, regulatory arbitrage, and data harvesting in a consumer credit market already quickly changing with technology,” the bureau announced in a statement.

Even without federal regulation, BNPL services may have different rules about credit reporting and payment enforcement. Make sure you follow the specific rules of your BNPL loan and keep up to date on potential changes so that you don’t land yourself in debt and with a lower credit score.

BNPL services were designed to benefit consumers, but without considering the risks, these tricky loans can do the opposite. Know your finances, understand your personal spending habits, and read the fine print of buy now, pay later loans. If purchasing with BNPL feels too good to be true, then it probably is.

College Voices″ is a guide written by college students to help young people learn about important money issues such as student loans, budgeting and getting their first apartment — and make smart choices. Jack Pedigo is a production intern in CNBC’s Washington, DC bureau. He is a junior at Georgetown University, studying international culture, politics and journalism. The guide is edited by Cindy Perman.

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