The Dangers of Buy Now Pay Later Schemes
Buy now pay later schemes can be a handy way of instantly purchasing an essential item, but look a little deeper and you might find some nasty interest rates. Read on to find out the dangers of these schemes, the associated charges, when they can be useful and the alternatives to these schemes.
It’s easier than ever to get what we want when we want it — regardless of our bank balance. So-called buy now pay later schemes are a payment method that allows you to either split the cost of your purchase into a series of interest-free instalments or delay the whole bill.
On the surface, buy now pay later schemes may seem great, as they allow you to make an immediate purchase without paying straight away. However, they can have a huge impact on both your finances and your credit rating if you’re not careful.
Where did buy now pay later schemes come from?
Retailers have long sought innovative ways of offering credit in order to remove the initial price tag for customers, so buy now pay later schemes were perhaps something of an inevitability.
Now, customers can defer payment of goods or services for as long as 12 months. As long as the customer pays in full within this interest-free window, often referred to as the pay later date, they will not incur any cost of credit.
Financial systems in general are predicated on individuals’ capacities to indeed buy now and pay later. How else would the average prospective homeowner ever be able to take out a mortgage; how many people would be able to pay for a car in full on the spot?
Banks lend to one another in vast quantities. Global trade would decline in an instant in the absence of the liquidity that borrowing affords individuals and corporations alike.
This logic can be extended to the consumer level, but where it becomes complicated is when the interest implications of buy now pay later purchases are not made transparent to customers.
In 2020 the use of buy now pay later services nearly quadrupled in value, with around 5 million people using them last year. Partly because of this rapid growth and because of the risks that these services can pose, the buy now pay later industry faces further regulation to protect consumers from getting into high-cost, problem debt.
Regulation of the buy now pay later industry
It was announced in February 2021 that the Financial Conduct Authority (FCA) will regulate the buy now pay later industry. This comes after the publication of “The Woolard Review” which looked into the unsecured credit market.
As a result of these changes, buy now pay later providers will be subject to FCA rules meaning customers using their services will receive some extra protections. For example, if you have a complaint about a buy now pay later provider, you will be able to take it to the Financial Ombudsman Service which you couldn’t do before.
Buy now pay later providers will also need to carry out more in-depth affordability checks. Although many lenders conduct ‘soft’ or ‘hard’ credit checks, once they come under FCA regulations they will have to meet further requirements to make sure that customers can afford to use their scheme. This aims to minimise the chances of people taking on excessive levels of debt that they can’t afford.
The review also stated that buy now pay later providers should treat their customers fairly, especially those that are struggling with repayments.
It is not confirmed yet when these new rules will come into action. Further details on the regulation of buy now pay later by the FCA are expected in April 2021.
The dangers of buy now pay later schemes
While some buy now pay later purchases won’t register on your credit report if you repay the debt on time, any late or missing payments could potentially damage your score.
There is a risk that buy now pay later schemes may attract people who are already in financial difficulties and may be struggling to make their existing bills and payments. So adding the expense of buy now pay later could worsen the situation by putting them in further debt. This could have long-term implications, financially to debt and mental health.
The idea of not having to pay off that £200 online clothes order for another year can certainly seem attractive, but if the reason you’ve deferred payment in the first place is that you may not be able to afford it right now, it’s important to ask yourself if you’d be able to pay it off in 12 months’ time.
It is the consumer’s responsibility to read the small print and ensure they fully understand the terms of the buy now pay later agreement they’re signing up to. The customer should also factor in the possibility of a shift in their financial circumstances in the future.
The lender or retailer should uphold reasonable standards of credit underwriting and modelling and communicate the details of their offer in plain and simple terms.
Associated charges of buy now pay later schemes
If you make a buy now pay later purchase and have not fully paid up come the pay later date, you will be required to make a minimum monthly repayment, inclusive of fees and interest. Interest will often start from the date of purchase, backdating to include the interest-free window. Missed repayments will generally entail hefty penalties.
The APR after the interest-free window varies significantly, but will probably be somewhere between 20–40%. However, rather than charging interest with a set APR, some retailers instead impose a monthly fee, either a percentage of the outstanding payments or a fixed amount.
The customer may be charged a settlement fee if they clear their balance in full after the pay later date. This will often act as a substitute for fees or interest, but in other cases may constitute an extra charge.
Can buy now pay later schemes be good?
There is certainly a time and place for being able to defer payment, and it doesn’t have to encourage unnecessary spending. If your boiler breaks down, rather than having to take days or even weeks going down through the extensive route of traditional finance options, you can replace it immediately without needing to cover the cost right now with upfront savings.
As the percentage of total retail spend that occurs in online shopping only grows, it makes sense for companies to offer buy now pay later at the point of checkout, making big-ticket items more affordable.
If customers are confident they will be able to repay the sum in full before the end-date, the buy now pay later scheme gives them the flexibility to pay for more expensive items in a way and at a time that suits them.
Alternatives to buy now pay later schemes
If you are uncertain about the short-term future and stability of your finances, you may want to consider alternatives to a buy now pay later scheme. For example, you could buy something second-hand. It can be surprising just how often high-quality items turn up on websites such as Gumtree, eBay and Depop after having been only used once or twice.
Alternatively, if you need to take out credit for an essential purchase, you could consider taking out a 0% balance transfer credit card on new purchases. It's important to understand your credit profile before you apply for a 0% interest credit card. As you generally need a good to excellent credit score to be eligible for a 0% interest credit card.
To protect your credit rating when using a 0% transfer credit card, it’s generally advisable to set up a direct debit and diarise payment dates. You may also wish to review your credit report on occasion, as this will give you a good overview of your credit arrangements and how well they are being managed.
Take time to consider a buy now pay later purchase
Buy now pay later schemes can be useful if you need a rapid turnaround on an essential item and are sure you can pay it off within the interest-free window, but they can also pose many hidden dangers to unsuspecting shoppers who are enticed by the deferred payments on non-essential products. In the absence of a solid understanding of the agreement’s terms and the potential associated charges, problems can creep up on customers and lead to spiralling debt. If this has happened to you, we can help you find free debt help, as well as provide you with information on how to understand debt consolidation.
Rhiannon is a financial writer for NerdWallet, with a particular interest in personal finance and insurance guides for consumers. Read more