Buy Now Pay Later: How it Works and What You Should Know

At online retailers and at registers these days, you may encounter the option to pay with a service known as “Buy Now Pay Later” (BNPL). It’s another way to pay, that doesn’t rely on credit or debit cards, or even cash.

Buy Now Pay Later services provide loans to consumers, letting them pay for something in installments, instead of paying the entire sum at checkout. BNPL companies operate by fronting the money to shoppers, and charging them over the course of a multi-month payment plan that they select. Rather than charging compound interest, as a credit card company might, Buy Now Pay Later companies often charge no interest, or less than credit cards do. 

And that’s one reason they have taken off with younger consumers, such as Gen Z and Millennials, who are looking for alternatives to credit cards. (Learn more here.)

The idea behind these businesses is that they let customers make big, often necessary, purchases without putting them on a credit card and potentially racking up debt. And in fact, they operate much like the layaway plans of old, which thrived before the invention of credit cards. But there are still risks. For example, some BNPL services will hit you with late fees if you miss payments. Missing payments might also negatively affect your credit score if the BNPL service you use reports to a credit bureau.

On the plus side, Buy Now Pay Later companies can also give people without a credit history access to credit. Retailers may benefit too. They often pay Buy Now Pay Later providers to feature them as a payment option on their sites. (In contrast, merchants must pay to accept credit cards.) Stores will reportedly pay even higher fees than they do to credit card companies because they expect consumers to spend more money with BNPL. Services such as Klarna, Sezzle, Afterpay, and Affirm offer point-of-sale short-term loans to consumers, paying the retailer upfront and charging the buyer in installments. 

How BNPL Works

Digital retailers will tell you which BNPL services they offer when you go to checkout. In order to use a BNPL service, you’ll have to download the service’s app on your phone. You’ll then have to provide basic information, such as your name, billing address, and sometimes your social security number. You’ll also have to verify your information with an email or mobile code, and accept terms and conditions. Then you can provide your method of payment, such as a credit card, debit card, or check. At checkout, you’ll make a down payment, and agree to a payment schedule. Payments will then be applied to your debit or credit card, or deducted from your checking account. 

You can also use these apps at the point of sale at retailers that accept them. Getting approval from a BNPL service can reportedly take less than 10 minutes.

How BNPL payments are structured

The payment terms for BNPL companies vary, but are often structured as four equal payments of roughly 25% of the owed amount, including taxes and any fees, with the first payment due at checkout. Some, like Afterpay and Klarna, offer you the ability to pay off your loan in four payments without interest, but will charge fees if your payments are late. Klarna also allows shoppers to pay back a loan interest-free in 30 days, an option known as  “Pay Later,” and offers long-term loans—from 6 months to 36 months—with interest. Others, such as Affirm, may charge interest as soon as you take out the loan, but don’t charge late fees. When you sign up to use Affirm, they’ll typically let you know how much your payments with interest will be, but you won’t pay extra fees if a payment is late.

The interest rates offered by certain BNPL providers can be comparable to those offered by credit card companies. Affirm, for example, charges an Annual Percentage Rate (APR), which reflects the annual interest rate you pay as well as fees, from 0% to 30% depending on how big the loan is, your credit score, and which payment structure you choose. Afterpay and Klarna, meanwhile, do not charge interest but can charge late fees up to 25% of the purchase’s value. 

In contrast, the average credit card rate is reportedly 16.22%, as of September 2021. Credit card interest typically compounds on a daily basis, which means that if you don’t pay off your balance within your billing cycle, you might owe a much higher amount than you originally did as the interest compounds. 

How BNPL can affect your credit score

For people who haven’t started building credit yet, or are rebuilding their credit, BNPL can be an alternative to credit cards. Afterpay, for example, reportedly instantly approves applicants without checking their credit score. Other options such as Klarna and Affirm perform soft credit checks. A soft credit check appears on your credit report when it’s checked for reasons that are not necessarily related to borrowing money, while a hard credit check appears on your report when you want to borrow money, for example by applying for a credit card, mortgage, or car loan. A hard credit check usually temporarily lowers your credit score, but a soft credit check doesn’t. “This can be an advantage if you don’t have a great credit score or any credit score at all, and it’s fast,” says Ted Rossman, New York-based senior industry analyst at Creditcards.com and Bankrate.com. 

Everyone’s credit situation and financial background is different. You should be aware of how BNPL can affect your credit before you sign-up for it. If a BNPL reports to a credit bureau, your payment history can affect your credit score. “Once you start using [BNPL], if you pay your bill on time, your credit score will….slowly improve,” says Carter Seuthe, chief executive officer of debt management company Credit Summit, based in Austin, Texas. On the other hand, Seuthe says if you fail to pay, your account will be marked as delinquent and that could affect your credit score. “If your account is handed to collections you will see a significant drop in score,” Seuth adds.

Nevertheless, staying on top of your payments if you decide to use BNPL is crucial. In a recent survey, 44% of respondents said that they’ve used BNPL to acquire an item they need. Of those who’ve used BNPL, 34% have reportedly fallen behind on one or more payments and 72% said they believed falling behind hurt their credit scores.

Other considerations before you use BNPL

Keep in mind also that you can earn points as you spend with a credit card, which you can use to pay down your bill, book travel, shop online, and more. You won’t earn those points using BNPL. (Remember that both credit cards and BNPL are forms of debt financing—paying off a loan over time—so you should be careful with both.) A credit card may be a more efficient way to build credit but if you don’t have a strong credit profile or want to avoid a ton of credit card debt, BNPL might be an option worth considering. 

And while BNPL companies often charge little or no interest, there can be hidden fees such as late fees. Missing payments could result in extra costs, and your debt could be sent to a debt collector. If your BNPL payments are taken automatically from your bank account, you should also be mindful of any overdraft fees that your bank charges, in case you don’t have enough in your account to cover the payments. As with anything, it’s important to read any fine print and disclaimers when you apply to use BNPL.

Another potential pitfall with BNPL is that, much like a credit card, it can increase the chances of accruing debt. While it might feel like you’re only paying a small portion of the cost you owe upfront, you will ultimately pay the whole sum over time, plus any fees. 

Follow the Stash Way

Whether you use BNPL or some other financial service to borrow, it’s important to practice good financial habits by budgeting for your essential and non-essential spending. Budgeting is part of Stash’s financial framework the Stash Way, which also includes saving for the short-term and the long-term, and making room in your budget to invest small amounts regularly. 

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