The Dangers Of Buy Now, Pay Later Schemes

Buy now, pay later schemes can be a handy way of instantly buying 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 alternatives to these schemes.

Rhiannon Philps, Brean Horne Published on 06 April 2020. Last updated on 27 September 2021.
The Dangers Of Buy Now, Pay Later Schemes

It is easier than ever to get what we want, when we want it – regardless of our bank balance. So-called Buy Now, Pay Later (BNPL) schemes are a form of payment that allow you to either split the cost of your purchase into a series of interest-free instalments, or delay the total bill for a period of time.

Used responsibly, buy now pay, later schemes can help you spread the cost of your online shopping. However, they can have a huge impact on your finances and your credit score if you are not careful.

Where did buy now, pay later schemes come from?

Retailers have long sought innovative ways of offering credit in order to reduce the upfront price tag for customers, so buy now, pay later schemes were perhaps inevitable.

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.

Some of our financial systems are predicated on an individual’s capacity to buy now and pay later. How else would the average prospective homeowner ever be able to take out a mortgage? And 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 recent years, the use of buy now, pay later services has grown massively. 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 – something you couldn’t do before.

Buy now, pay later providers will also need to carry out more in-depth affordability checks. Although many lenders currently 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. The aim is to minimise the chances of people taking on excessive levels of debt they cannot afford.

The review also stated that buy now, pay later providers should treat their customers fairly, especially those who are struggling with repayments.

It is not confirmed yet when these new rules will come into action. But the FCA has announced plans to consult on new rules for buy now, pay later schemes 2022.

The dangers of buy now, pay later schemes

Buy now pay later schemes can negatively affect your credit score if you miss a repayment.

As harmless as a late payment on a buy now, pay later purchase may seem, it could affect your eligibility later on. Missed or late payments can be recorded on your credit report for six years.

This could harm your chances of being approved for new credit, including a personal loan, credit card or mortgage.

There is a risk that buy now pay later schemes may attract people who are already in financial difficulties and 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.

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 have deferred payment in the first place is that you may not be able to afford it right now, you need to ask yourself if you would be able to pay it off in 12 months’ time.

It is important to understand the small print of a buy now, pay later scheme before signing up. We have done some digging and found that some of the buy now, pay later scheme terms and conditions are challenging to read. But don’t let that put you off.

If anything is unclear, get in touch with the buy now, pay later provider to find out more. This will help you avoid any unexpected shocks like late payment fees or damage to your credit score.

Associated charges of buy now, pay later schemes

If you make a buy now, pay later purchase and have not fully paid up by 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 can be between 20% and 40%. However, rather than charging interest with a set APR, some providers instead impose a monthly fee, either a percentage of the outstanding payments or a fixed amount.

A customer may also 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 going through traditional finance options, you may be able to replace it immediately without needing to cover the cost right now with upfront savings.

Making your buy now, pay later repayments on time can help improve your credit score. It shows lenders that you are able to manage money well and can afford to repay what you borrow. This increases your chances of being approved for new credit in the future.

» MORE: 15 ways to improve your credit score

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 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 for new purchases. Take time to understand your credit profile before you apply for a 0% interest credit card though. Generally, the higher your credit score, the better the deal you might be offered.

To protect your credit rating when using a 0% transfer credit card, you may want to set up a direct debit and diarise payment dates. It is also worth checking your credit score and eligibility for new credit before applying. This will help you gauge which products you are more likely to be accepted for. This may reduce the chances of lenders turning down your application, which could negatively impact on your credit score.

Think carefully before using interest free credit cards because should you fail to pay off credit card debts in full you run the risk of all the issues discussed about BNPL schemes, and the amount you owe could quickly spiral out of control.

» MORE: What is a good credit score for a mortgage loan or credit card?

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 be dangerous for 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 potential charges, problems can creep up on customers and may lead to spiralling debt. If this has happened to you, we have a guide on how to get free debt help, as well as provide you with information on how to understand debt consolidation.

About the authors:

Rhiannon is a financial writer for NerdWallet, with a particular interest in personal finance and insurance guides for consumers. Read more

Brean is a personal finance writer at NerdWallet. She covers a range of financial topics and has written for consumer titles including Which?, Moneywise and The Motley Fool. Read more

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