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"Buy now, pay later" payment plans may have a catch: Your credit score

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"Buy now, pay later," or BNPL, payment plans let consumers break up their total purchase at checkout into a series of smaller installments.

Though these plans aren't new, they've recently catapulted into the mainstream, with major U.S. retailers like Amazon, Walmart and Target now offering them. Mastercard in September also unveiled its own buy-now-pay-later products amid strong consumer demand during the pandemic. 

But with promises of convenience, zero interest and minimal fees, many shoppers are wondering, "What's the catch?"

It could be your credit.

BNPL providers don't typically report on-time payments to the major credit bureaus, so unlike with credit cards or loans, you can't build credit with this type of financing. Some providers will report missed payments, though, which could end up hurting your score.

Experts also warn of risks, such as hidden fees and a lack of consumer protections, that might not be immediately apparent to borrowers.

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BNPL and the credit bureaus

Afterpay, an Australian company that provides BNPL payment plans to over 16 million shoppers in the United States alone, doesn't interact with the credit bureaus at all, including when shoppers first apply for approval.

According to Nick Molnar, co-founder and co-CEO of Afterpay, checking a shopper's credit file has "no positive correlation" to the company's ability to reduce losses. Instead of conducting a soft or hard credit pull, the company applies safeguards like pausing a shopper's account after one missed payment, which Molnar says customers appreciate.

"I think this next generation is looking for these products that have their best interest at heart," he said. "At its core, that's why we've been able to grow as fast as we have."

Though this approach means easier approval for those with no credit or bad credit, shoppers can't use Afterpay payments to demonstrate responsible use of credit to the bureaus. On-time payments are the largest contributor in determining FICO credit scores.

Afterpay isn't alone. BNPL companies Klarna and Affirm also don't typically report payments for their no-interest plans.

This practice is especially harmful for young people who may need to access credit to lease or buy a car, rent an apartment or buy a house, says Bruce McClary, senior vice president of communications for the National Foundation for Credit Counseling.

"There are so many circumstances in the life of a younger consumer where credit checks are required," McClary said. "It's very difficult to work around the types of situations where your credit report may be a consideration."

BNPL providers may report missed payments

Though BNPL providers may not report on-time payments, some still report missed payments.

For example, Zip, previously Quadpay, doesn't report payments to the bureaus, but it will send past-due accounts to collections, which can affect your score.

Pamela Capalad, a certified financial planner based in Brooklyn, New York, said missed payments are the biggest risk when using a BNPL service. Because the installments can be automatically billed to your debit card, you could overdraw your account, resulting in penalty fees, before ultimately defaulting on the loan. This can hurt at a time when you're particularly vulnerable.

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"Often the people who are using these types of plans need to break up the payments for one reason or another," Capalad said. "To have that affect their credit at the same time, I don't think that's a good thing."

McClary noted how one missed payment could also lead to costly financing in the future, since interest rates will likely increase for borrowers with lower credit scores.

"Once the debt collection account shows up on the credit report, it creates a more significant barrier to overcome," he said. "The cost of borrowing goes up as your credit score goes down."

BNPL products experienced high-double-digit growth during the COVID-19 crisis, outpacing rival types of unsecured loans such as credit card debt, as more Americans flocked to ecommerce during the pandemic, according to McKinsey. Demand for the loans is expected to continue to exceed other types of consumer lending, with the consulting firm projecting compound annual growth for the products of as much as 20% through 2023. 

Alternative ways to build credit

Both Capalad and McClary acknowledge that BNPL payment plans can be a valid way to budget for large purchases, particularly if the plan charges zero interest and you can make the payments. But if you're focused on building credit, it's best to look elsewhere.

A secured credit card is a smart alternative. It requires a cash security deposit, usually equal to your line of credit — a $300 deposit for a $300 spending limit, for example — and you don't need good credit to qualify . Once you're able to upgrade to an unsecured card, you'll receive your deposit back.

For those new to credit cards, Capalad recommends putting a small recurring expense on the card, like your Netflix subscription, and setting it to autopay. This approach allows you to use the card consistently without overspending.

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Another option is a credit-builder loan, which you can find at credit unions, banks and some online lenders. Unlike a traditional loan, you'll make payments first then receive the money. Payments are reported to the credit bureaus.

By showing a history of responsible financial behavior, you can build your credit profile and access more affordable financing in the future.

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