Why You Should Think Twice About "Buy Now Pay Later" Options

If you shop online, whether it's for anything from furniture to electronics to airline tickets, you might have noticed an alternative checkout option to "buy now, pay later" through a monthly payment plan. More and more retailers are partnering with third-party financial technology companies, such as Affirm, Afterpay, and Klarna, among others, to offer consumers low- or zero-interest financing for purchases that provide extra time to pay.

These flexible, pay-over-time financing options are called point-of-sale loans, or POS loans. In some instances, POS loans are offered at checkout to break up one single purchase into smaller monthly payments. In other instances, online shopping consumers may sign up in advance with a payment platform that partners with certain retailers and offers the option to choose an installment plan upon checkout.

A POS loan is a type of installment financing that's considered an unsecured loan and has typically been used for high-priced items, such as furniture, large appliances, or jewelry. However, the option to "buy now, pay later" is increasingly appearing for smaller purchases everywhere.

POS loans can be a convenient form of financing when you don't immediately have funds available to make a purchase. But, as is the case with all loans and financial products that could impact your credit score and overall financial health, it's important to exercise caution and be mindful of what "buy now, pay later" loans entail, especially during unpredictable economic times. Here's a breakdown of some of the pros and cons of POS loans, risks to consider, and warning signs to look out for, as well as tips and tools on how to budget.

How it works

Securing a POS loan is a simple process. At checkout when online shopping, a consumer will apply for credit (just enough to cover the specific purchase amount of the item) by providing some basic information, such as one's date of birth, phone number, email address, and debit or credit card number. Once the consumer is approved, they'll pay a portion of the bill at checkout and the remaining balance via installments over a fixed period of time.

There are generally two categories of POS loans, depending on the price of the item a consumer is purchasing. For goods that cost $1,500 or less, payment plans will often divide repayment into four equal installments scheduled across six weeks. These plans won't usually charge interest and this loan won't normally impact your credit score (however, you should always read the fine print, because while they may not usually impact your credit or charge interest/fees, some may). For purchases higher than $1,500, payments are spread over a longer period of time, often up to 48 months, and consumers may be charged interest, with interest rates that could run as high as 30 percent.

Pros

• No interest: "Buy now, pay later" lenders generally do not charge interest on POS loans for purchases that are roughly $1,500 or less.
• No late fees: Some POS lenders don't charge late fees, which can be a big draw for consumers.
• Quick approval: It's often easy to secure a POS loan, with approval usually occurring in seconds when applying online at checkout.
• Easy repayment: POS loans of $1,500 or less are usually structured to be paid off in four installments. Many "buy now, pay later" lenders also require customers to keep a credit card on file and will enable autopay, which can help customers avoid forgetting payments.

Cons

• Too much debt: Because of the ease of securing POS loans, consumers may take out multiple loans for various purchases and accumulate more debt than they're able to repay. Additionally, if a consumer doesn't have enough money to make a payment, it could potentially result in charges from both the consumer's bank and the POS lender.
• Damage to credit score: Credit bureaus, such as Transunion, Equifax, and Experian, are beginning to include POS loan data into credit reports. This may be a good thing if you have a track record of making on-time payments, which can boost your credit score. But a late payment on a pay over time loan could negatively affect your credit score—and make loans more difficult to secure and expensive to borrow in the future.
• Fees: Some POS loans charge service fees to set up POS loans and late fees for missed payments, which may range from $7 per missed payment for loans around $135, according to the Consumer Financial Protection Bureau.
• Additional interest: Even if your POS loan doesn't charge interest, if you're paying off your loan with a credit card that you don't pay off in full each month, you'll still end up paying interest on the credit card.

To consider before you apply

When it comes to POS loans, the biggest question to consider is whether or not you can comfortably afford the monthly payment for what you want to purchase, as well as whether or not you'll be able to afford this monthly payment through to paying off the item. This decision may vary by item: $75 per month for a new refrigerator may be a good deal, but $75 per month for new shoes may not offer the same value. Either way, it's important to decide whether you want to be, or can afford to be, paying off an item for six weeks, six months, or longer—especially if you're planning other financial moves in the future, such as buying a house or car, where your debt-to-income ratio is a factor.

Another consideration is whether or not you decide to return the item. Before financing a POS loan, find out what the return policy is. It's prudent to know whether you can receive a refund, whether there are shipping or restocking fees, and if there are penalties to paying off a loan early.

Just like any financial decision, before securing a POS loan it's important to read the fine print to see if that particular loan requires a hard credit inquiry. When companies pull your financial information from credit bureaus, it could impact your credit score. Determine whether or not the pay-over-time lender reports to the credit bureaus, which may harm your score if you are late or miss a payment. Also, confirm whether or not your "buy now, pay later" loan comes with 0% APR financing. If not, calculate how much the loan's interest may cost over time. Some POS loans may also have high fees if a payment is missed.

POS alternatives and tips

Amid rising inflation and a potential recession on the horizon, POS loans can create a slippery slope for consumers, especially if you have more than one. If you need to purchase a high-priced item, it's important to consider creating a budget that allows you to set aside funds on your own without risking your credit.

Instead of securing a "buy now, pay later" loan that requires multiple payments over six weeks or longer, and which possibly includes a hard credit inquiry that could affect your credit report, consider waiting a few weeks and saving the money on your own. For items that are wants but not needs, wait three days before making a purchase, especially for nonessential goods, such as fast fashion finds or novelties. By doing so, you can avoid impulse purchases you may regret later.

To learn more about savvy ways to save, building credit, or dealing with debt, visit Bank of Hawaii's SmartMoney learning center.

The individuals and owners of any trademarks, logos, brands or other designations of origin shown, named or mentioned herein did not sponsor, endorse or preview this article.

The content in this article is for informational purposes only, and should not be construed as tax, legal or accounting advice by Bank of Hawaii and its affiliates. You should consult your own tax, legal and accounting advisors.