Here's how services like buy now, pay later affect your credit scores

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According to Salesforce, between November 23rd and November 29th of 2021— also known as Cyber Week—$22 billion worth of purchases were financed globally using buy now, pay later financing (BNPL). That’s a 29% increase from the previous year. Spearheaded by firms like Affirm, Klarna, and Afterpay, the movement appears to be taking off.

One of the appeals of BNPL is that lenders don’t do a hard credit inquiry for approval. They do a soft inquiry to confirm that the buyer is in a certain credit score range. The soft inquiry doesn’t affect the credit score, so many buyers prefer BNPL over applying for a store credit card. They believe the loan is “invisible” to the credit bureaus. That’s not the case. 

Equifax and Experian Report on BNPL Loans

Equifax developed a formal process for reporting on BNPL loans last December (they have been doing it since 2016.) TransUnion is adopting a new system this month. Consumers need to know that the credit bureaus are paying attention. Buy now, pay later is no longer under the radar. It’s become a mainstream credit option.

Soft credit inquiries might not be reported, but on-time payments are. So are late payments and defaults. That’s not designed to penalize the consumer. It puts the credit bureaus in a better position to monitor BNPL, which is still relatively new in the world of finance. Having more eyes on it will benefit consumers as its popularity increases.

Younger Consumers are using BNPL to Build Credit

Tracking on-time payments for BNPL loans gives younger consumers an opportunity to build credit without subjecting themselves to hard credit inquiries and high credit card interest rates. Financing a smaller purchase using BNPL will establish a history with the credit bureaus. It’s also an option to make larger purchases they can’t afford to pay cash for.

Of course, traditional lenders know all this and are targeting subprime borrowers with easier application and approval processes. Before initiating a BNPL purchase, young people should investigate other means of financing, like low-interest credit cards or unsecured personal loans. This due diligence might also slow down the impulse to buy now.

How BNPL Can Hurt Your Credit Score

Late and missed payments affect your credit score. Defaulted loans and collection activity can stay on your credit report for up to seven years. The new reporting on BNPL opens borrowers up to those risks. It’s important to be aware of this before agreeing to any type of financing. Read the contract carefully to make sure you can afford the payments.

Interest rates may be low, but there could be fees and additional charges embedded in the contract. There are also stipulations on those “money-back guarantees.” Many of them have time limits. Clarify what those are before the final sale. You may not be able to return the item if it turns out you can’t afford it. That will damage your credit. 

The Bottom Line: Is BNPL the right choice for you?

With the new reporting processes by the credit bureaus, BNPL loans now fall into the same category as unsecured personal loans and credit card debt. In some cases, one of those might be a better option. Research all these carefully before making your final purchase. Better yet, don’t buy it if you can’t pay cash for it.

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