Is 'Buy Now, Pay Later' Too Good to Be True?

Are these free loans really free?

Buy now, pay later (BNPL) options have become increasingly popular in recent years. According to the Consumer Financial Protection Bureau (CFPB), from 2019 to 2021, the number of BNPL loans from the top five U.S. lenders grew by 1,092%, from $2 billion to $24.2 billion. Why has this payment option grown so quickly?

These services allow shoppers to purchase an item or service upfront and then pay for it over time, typically with no interest. This type of financing option can be extremely helpful for those who need a bit of extra time to save up but don't want to miss out on an opportunity or deal that might not be available much longer. But is BNPL too good to be true? Here's how these programs work and what you need to know before signing up.

How does BNPL work?

In order to understand how BNPL works, you first need to know the basics of how credit works. When you sign up for a credit card, you make a promise to the lender that you will repay what they lent you within a certain amount of time with interest. With BNPL, this process is simplified and streamlined, as there are typically no interest charges or late fees associated with these services.

In addition, there is no credit check required with BNPL since withdrawals come directly from your bank account. Shoppers typically pay off their purchases in fixed installments over a set period of time that usually ranges from three to 12 months depending on the provider.

The pros of BNPL

Like any financial product, there are pros and cons that come along with using buy now, pay later options. On the one hand, it allows consumers access to items they may not otherwise be able to afford by breaking down payments into smaller chunks. This can also help buyers manage cash flow more effectively, as well as build their credit score if done responsibly.

The biggest benefits of BNPL plans is that many do not charge interest or late fees. You can be approved for a BNPL plan in seconds without a hard credit check, so applying won't hurt your credit score. BNPL loans also have a flexible repayment plan, where you can spread out your payments over time.

The cons of BNPL

While there are some benefits to BNPL loans, according to one survey, 1 out of 4 (22%) Americans who have used BNPL have immediately regretted their decision, saying they wished they had not signed up for the plan. Why? In a study, the CFPB states that BNPL "is engineered to encourage consumers to purchase more and borrow more. As a result, borrowers can easily end up taking out several loans within a short time frame at multiple lenders or Buy Now, Pay Later debts may have effects on other debts."

Nearly a third of BNPL users report that they have struggled to make the payments and in order to avoid defaulting on their plan, they had to skip paying an important bill. Defaulting on a BNPL plan can also lead to your credit score taking a hit. You also don't get points, miles, or cash back like you might with a rewards credit card.

More BNPL plans are starting to charge late fees as well as interest. If shoppers are unable to complete their repayment plan, they could end up being charged late fees or even incur additional costs from their provider -- which could lead them into debt if they're not careful. While BNPL plans advertise that there are no fees, only 52% of those surveyed stated that their plan was completely free. Meanwhile, 14% said they paid a flat fee; 7% paid late fees; 8% paid interest of 30% APR or less; and 4% paid an APR higher than 30%, with the remainder not knowing how much interest they paid.

Are BNPL plans worth the risk?

When used responsibly, buy now, pay later options can be incredibly useful for managing cash flow and building credit scores while still allowing shoppers access to products they may not otherwise have been able to purchase upfront. It's important for potential customers to understand the terms and conditions associated with each provider before signing up. This way they can make sure they're comfortable with all aspects of the agreement before committing themselves financially. When used correctly and carefully, BNPL services can be an effective way for shoppers to get what they want without having to break their budget.