Online shopping has been on a tear this year, and consumers are flocking to “buy now, pay later” services. But you should tread carefully before buying something you can’t afford today. And a credit card may be a better option for financing a big purchase.
Online shopping has been on a tear this year, and the “buy now, pay later” industry has been riding its coattails.
One of the leading players, Afterpay, processed $2.1 billion in global sales last month, up 112% from November 2019. Its U.S. sales were up 205% to $1 billion. Klarna counted its 11 millionth U.S. customer in mid-November, just three weeks after hitting 10 million. Another big player, Affirm, is preparing for an initial public offering that The Wall Street Journal says could value the company as high as $10 billion.
See related: Buy now, pay later with installment plan services
How the plans workThe most common example involves paying off a purchase in four installments spread over six weeks with no interest. Sometimes you can get a lot more time with 0% APR, like Affirm’s 39-month 0% partnership with Peloton that allows some customers to pay as little as $49 per month for a bike worth nearly $2,000.
Other times, stretching beyond those first six interest-free weeks can cost you substantially (up to 30% APR). The terms vary depending on the service, the retailer and your personal circumstances. Soft credit checks are common. The application process is quick and easy, but even this cursory glance can result in rejections or higher rates for applicants with lower credit scores or a lot of debt.
Bank of America believes the buy now, pay later industry will grow by another 10x-15x within the next five years, which at the high end of that range would equate to roughly $1 trillion in transactions.
I see the appeal, but it’s not my preferred payment method. I suggest using a credit card and paying it off before interest accrues, thereby eliminating the one big con and enjoying credit cards’ superior rewards programs, fraud protections and other buyer protections (such as extended warranties and purchase protection).
Debit cards and buy now, pay later companies don’t come close in any of those areas. Still, just like you and I might order different meals from a restaurant menu, we might make different payments choices.
Who uses buy now, pay later
Conventional wisdom was that buy now, pay later was for young people without much money or much credit. This is still true to some extent – picture the Gen Zer without a credit card who wants to finance some new clothes, electronics or furniture. But nowadays, most buy now, pay later users are the so-called HENRYs (high earners not rich yet).
Cornerstone Advisors reports that seven in 10 buy now, pay later customers earn more than $75,000 annually. They tend to be college graduates and the vast majority have credit cards. Bank of America adds that they’re usually in their 30s and the typical purchase they finance is between $200 and $500.
The sweet spot is a debt-conscious consumer who wants the flexibility to finance a purchase but with the certainty of a clearly defined payoff date. Open-ended credit card debt scares them. But if they know exactly how much they owe per month, and exactly how many weeks or months the loan will last, this makes them feel better.
Why usage is surging now
Buy now, pay later has been around for a while – Klarna was founded in 2005, Affirm in 2012 and Afterpay in 2014. The concept really caught fire in 2020. The pandemic spurred a massive rise in online shopping (some buy now, pay later services can also be used in person, but it tends to be a digital-first concept).
At the same time, many consumers experienced shocks to their income – or at least the fear that one might be coming – and many had their existing credit card limits cut by risk-averse issuers. In a sea of uncertainty, if you really want to upgrade your wardrobe or home, you might gravitate to buy now, pay later as a more stable source of financing. You get your merchandise right away with a clear plan for paying it off. You feel more responsible about this debt because you know exactly how many weeks or months it will last. Sometimes it’s even interest-free.
Large, established financial institutions have caught on, too. American Express launched Pay It Plan It in 2017 (card members can make flexible payments for purchases of $100 or more; the fixed plan fees are typically lower than their regular interest rates). Citi and Chase unveiled similar features last year.
And PayPal has a lot of skin in this game as well, dating back to its 2008 acquisition of Bill Me Later. PayPal currently offers two different buy now, pay later concepts (PayPal Credit, which centers around a six-month 0% deferred interest promotion, and Pay in 4, which is another of the interest-free six-week installment plans).
See related: What is deferred interest?
There’s certainly a place for buy now, pay later in the payments ecosystem. Still, I believe you should tread carefully. There’s always a risk of buying something now that you may not be able to fully afford. While you may feel better about paying it off in six weeks or six months, what if you can’t? Debt, late fees and credit score damage could pile up.
Also, buy now, pay later plans don’t usually report positive payment information to the credit bureaus, and some customers have difficulty resolving disputes about returns, damaged merchandise and other aspects of the transaction.
For all these reasons and more (like rewards), credit cards are generally the superior choice, particularly if you can avoid interest. And if you can’t, maybe it’s best to hold off on that discretionary purchase.
Have a question about credit cards? Email me at firstname.lastname@example.org and I’d be happy to help.