What was born first, the chicken or the egg? How about credit scores or buy plans now, pay later? That’s a similar conundrum for many, especially young people, immigrants, and others who are less likely to be judged by traditional credit scoring methods — and therefore may be attracted to alternative sources of funding like buy-out, pay later.
There will soon be a closer link between credit reporting and buy now, postpaid (BNPL), as Equifax recently announced its first policy in the industry on accepting BNPL transactions into consumer credit files, and Experian is set to launch what it calls the industry’s first “Buy Now Post Office.” Shortly thereafter, TransUnion – another major credit bureau – made a similar announcement. Nevertheless It’s not entirely clear how to do any of these things and there are some potentially unintended consequences for consumers.
The basic concept of BNPL
Vendors such as Affirm, Afterpay, and Klarna allow customers to pay for purchases in advance. The most popular version is four interest-free payments spanning six weeks. Sometimes the plans last much longer, with or without profit.
For example, some people may avoid paying interest on a $2,495 Peloton Bike+ for nearly 4 years through the fitness company’s partnership with Affirm. Eligible applicants will have to pay about $58 per month for 43 months without paying and without interest.
On the other hand, some affirm plans have interest rate ratings, reaching a whopping 30% based on the credibility of subscribers. Klarna, too, has a huge disparity between interest-free plans and others that charge an annual percentage as high as 24.99%.
For both Affirm and Klarna, the midpoint similar to the APR of the average credit card is 16.28%. Before committing to buy now, the postpaid plan, it is important that you investigate your specific terms. Let’s go back to the Peloton example: $58 per month sounds affordable, but there’s still a risk of overspending. Do you really want to be in debt for the next 43 months to pay off an expensive, non-essential item? Plus, many consumers have several BNPL plans running simultaneously, which further obscures the total cost of ownership.
Who uses BNPL?
Many BNPL users are attracted to the easy access to credit and the immediate satisfaction of getting an item now and paying for it over time (hence, the nickname “reverse dismissal” that some have bestowed on BNPL). It has become a $100 billion industry, supported by specific retail partnerships and pandemic-related favorable conditions such as the rise of e-commerce and greater awareness of debt and other personal finance issues.
Because they know exactly how many weeks or months they owe, some people prefer BNPL. The open structure of credit cards can leave them in debt for a very long time, especially if they only make minimal payments. In addition, BNPL plans are often easier to qualify for than credit cards. Most BNPL providers only conduct soft credit checks. In addition, they have yet to be governed by federal regulations regarding borrowers’ ability to repay loans, though the Consumer Financial Protection Bureau recently announced that it is taking a closer look at the industry’s practices.
Clearer credit reporting standards would be very good. BNPL plans are especially popular among young people, which brings us back to a dilemma like that chicken or egg. A Bank survey in January 2022 found that only 55% of Gen Zers (18-25 years old) had a credit card. This number rises to 66 percent of millennials (ages 26-41), 77 percent of Gen Xers (ages 42-57) and 85 percent of baby boomers (ages 58-76).
This is partly because the CARD Act, which came into effect in 2010, makes it much harder for young people to get credit cards (especially before their 21st birthday). It can also be self-selected as many 20-year-olds are saddled with student debt and wary of taking on more consumer debt. BNPL plans are a form of debt, although many see them differently, perhaps because they are often short-term commitments with built-in lighting at the end of the tunnel.
It can be difficult to establish a credit history. Experian said at least 49 million Americans cannot be assessed using traditional credit scoring systems because there is not enough information about their credit habits. Access to credit has become a major topic in recent years, inspiring alternative credit scoring models such as the Experian Boost. And startups like Petal and TomoCredit are taking advantage of new approaches to providing credit cards to young people, immigrants and other previously underserved groups.
BNPL and credit scores are virtually separate
So far, the majority of BNPL plans have not been reported to credit bureaus. Affirm reports some of its long-term plans to Experian, but that’s the exception, not the rule.
Equifax said most consumers in its BNPL pilot program have experienced improvements in their credit scores, thanks to on-time payments, with an average FICO score increase of 13 points. The improvement was even greater (21 points) for individuals with “thin” credit records (two or fewer occupations) or “younger” profiles (credit histories shorter than 24 months).
I’m willing to include “alternative” credit indicators in consumer credit reports. In fact, I’m putting “replacement” in quotes for a reason. The credit reporting industry tends to view things like streaming services, mobile phone plans, rent payments, and utilities as “alternatives” because traditionally, they don’t count toward credit scores. But I argue that the fundamentals are very similar. These are monthly financial obligations, such as credit card bills, car loans, and mortgages. It only seems fair to count them into a consumer’s credit score.
I believe BNPL plans should be counted towards credit scores, but this needs to be done properly. There are some key nuances that still need to be arranged.
The challenges of adding BNPL to credit scoring
A potential concern is that regularly opening a credit account is often considered risky behavior. Too many difficult questions are not recommended because opening multiple credit accounts at once can lead to a desperate situation. Usually, you should accumulate no more than five or six difficult questions over a two-year period. This may not apply much to BNPL users as those people tend to be light-hearted questions. However, credit scoring algorithms also assess the age of a consumer’s account (about the average age of those accounts as well as how the latest account was opened recently). If every BNPL plan shortens the average age in a person’s credit history, they can have an unintended negative impact on a credit score.
Another potential consequence is whether BNPL represents an installment loan or credit line. If it is a credit line, how will the use of credit be assessed? On credit cards, the amount of credit you’re using divided by the credit line is an important component of your credit score. In other words, if you’re using $4,500 in the $5,000 credit line, then that seems risky to the lender because you’re dangerously about to use that card.
But BNPL plans tend to be underwritten on a transaction-by-transaction basis, rather than a larger, open credit line. If you’re funding that $2,495 bike with 43 payments of $58 and your “credit line” is considered $2,495, then your credit utilization rate (at least for that transaction) will be increased for a while. This can inadvertently affect a consumer’s credit score even if they comply with their monthly financial responsibilities.
Finally, is negative information (such as late payments) reported? Traditionally, both positive and negative information have been reported to credit bureaus, although some newer credit scoring techniques — such as Experian Boost — only incorporate positive data.
The bottom line
It remains unclear how credit bureaus will incorporate BNPL into consumers’ credit records. In particular, Experian and TransUnion seem to be focused on creating specific BNPL rating systems that lenders can opt into if they wish.
These new systems can avoid the aforementioned unintended consequences of connecting BNPL to traditional loans and credit lines. They can help lenders distinguish the amount of unpaid BNPL debt a prospect has, along with the total amount of BNPL loans and BNPL payment history. But just like other new credit reporting methods, it will take a long time for them to be widely used.
Equifax, on the other hand, is committed to integrating BNPL with existing credit reports. The company’s chief product officer, Mark Luber, emphasized that this is a consumer-friendly development (assuming that the use of BNPL by consumers is advantageous) as they are more widely used than niche indicators.
Luber points out that BNPL plans are more likely to be considered revolving credit, thus avoiding concerns about opening and closing accounts regularly. This means that the use of credit is also an important factor. And he confirmed that both positive and negative information are reported.
Finally, it seems that the credit monitoring industry is working to incorporate BNPL plans into its calculations, but these changes won’t happen overnight. Equifax is probably the furthest company but is still in the early stages of collecting data from BNPL providers.
Do you have questions about credit cards? Email me at firstname.lastname@example.org address and I am happy to help.