Online retailers are aggressively marketing a service called buy now, pay later (BNPL). Have you heard of Affirm or Klarna? They are part of a growing list of digital services for consumers that are turning the traditional layaway model on its head—and now, potentially your credit score.
According to financial planner, Jeff Dortch of Civic Federal Credit Union, “buy now pay later services are like a reverse layaway that, if used too much, can now potentially have negative impacts on your credit score.”
Layaway Versus Buy Now, Pay Later
Traditional layaway is where the retailer holds the product for you while you make payments, usually with cash. Once you pay the total price, you receive the item. Many financial planners can get behind this model because the item is being purchased with your own available money and is not adding to any debt you may have.
In contrast, Affirm and Klarna are buy now, pay later digital services that give you immediate access to the product as you make payments for four months with 0% interest.
This type of instant service may be helpful to solve an emergency need, but it may also create credit score issues for people who use them too much.
New Impacts to Your Credit Score
In the past, the short-term nature of your BNPL activity would not require a hard pull of your credit and would not have any impact on your credit score.
That has now changed. Your BNPL activity will now be included in reporting to the three major credit agencies: TransUnion, Experian, and Equifax.
Why does this matter to you? In the eyes of a credit bureau, each time you use BNPL you are opening and closing a credit account, for each separate purchase. If you use BNPL often, you are creating a potentially negative credit story for the major credit bureaus.
How? The FICO credit reporting algorithm rewards you when you open a credit account and make timely payments but it penalizes you for closing an account.
Dortch explains, “Each time someone uses BNPL, they create and close a credit account. For people who use BNPL multiple times at the same time, they may have four separate credit lines open at one time,” he shared. “That is four account closures and four times to lower your credit score under the current scoring algorithm.”
Looking Ahead: Evolving Rules
Based on consumer feedback about the impact of BNPL on credit scoring, TransUnion and Experian are now partitioning off BNPL activity in a separate credit section, while Equifax is taking a more wait-and-see approach.
As the credit bureau rules about BNPL continue to evolve, Jeff Dortch suggests you know:
5 Things to Consider for Buy Now, Pay Later and Your Credit Score:
- Treat BNPL as any other credit or credit-like product; make good choices.
- Pay attention to how often you use BNPL, especially if your credit score is 700 or lower.
- Be sure to make payments on time.
- Do not open multiple BNPL lines at the same time.
- Resist using BNPL for impulse purchases
Looking ahead, there is some consensus that FICO may make future adjustments to the credit scoring algorithm. Until then, consumers, credit agencies, and FICO are trying to figure out ways to not penalize people for using BNPL services.
According to Jeff Dortch, “The same risks that apply for any credit-like product apply to BNPLAs as with any credit product. It is important to avoid multiple lines at the same time and make timely payments.”
Disclaimer: You + Money blog posts are provided for informational purposes only and not intended to replace the advice of a financial, legal or accounting advisor.