What is Buy Now Pay Later & How Does it Work?

Have you seen Buy Now Pay Later (BNPL) options as you shop online and wondered how this opportunity works? If you prefer to divide payments over time instead of paying the entire purchase price instantly or putting it on an existing credit card, BNPL financing can be a good choice.

Like any type of credit, however, it's important to learn the pros and cons so that you can fully understand when opting for BNPL can make financial sense.

BNPL is a financing option where instead of paying with cash, debit card or credit card for the entire cost of an item upfront, BNPL allows you to make a preset number of payments over time.

For example, with BNPL, if you purchase a $400 item, you may see a BNPL option that breaks the cost into four $100 payments or installments. Agreements may not require an initial payment, instead deducting payments automatically from your bank account at set dates in the future.

BNPL is typically available as a payment option on eCommerce websites, and may also be available at physical brick-and-mortar retailers.

This form of credit may be used by retailers to help consumers make small-to-medium-sized purchases such as clothing, electronics, furniture and appliances. Eligible customers that meet approval criteria can usually get their approval decision on the spot, either in-store or online.

Terms are established up front and often include monthly or biweekly payments, so budgeting ahead of time for the installments will be crucial.

Check the terms of your BNPL loan to understand whether there will be interest charges or late fees, and how they work. Some loans are interest free, while others require customers to pay interest with each payment.

BNPL is an increasingly popular form of payment among Americans, with 19% of Americans having used BNPL in the past year. But when does it make sense to consider BNPL?

Let's take a look at these scenarios when BNPL might be the right choice:

1. You have the money available for the purchase but prefer a small, interest-free loan because you know you'll pay the installments on time.
2. You don't have the cash available on the date of purchase, but you're confident that you'll be able to make payments by their due dates.

In either case, there's a little risk—so the decision to take on a BNPL loan depends on your personal payment preference and how you manage your monthly finances and cash flow. However, despite your best intentions, unexpected financial difficulties can arise which may make it impossible to make a payment on time. In fact, 26% of Americans who have used BNPL have missed or made a late payment.

Creating a budget is critical when using BNPL options, because you may be approved for something and then find it challenging to manage the ongoing payments. For example, if you make multiple purchases with BNPL, you’ll have several BNPL loan payments due each month, so be sure to keep track of each one as a part of your overall budget.

If you don't keep up with what is due, you might find yourself with some surprises such as fees and interest payments.

Most BNPL services run a soft credit inquiry where they review your creditworthiness in a way that doesn't impact your credit scores; it can be done almost instantly with minimal information from you.

However, certain BNPL options might run a hard inquiry of your credit reports. A hard inquiry of your credit scores will show up on the inquiries section of your credit reports for two years, and can impact your credit score.

BNPL services can report your installment payments as either on time or late to the major U.S. credit bureaus—Equifax, Experian, and TransUnion. The bureaus use this information when they calculate your credit score, which means BNPL may impact your credit score. A good credit score can help you secure financing for an auto loan, get approved for an apartment, etc.

Since both BNPL and credit cards can help you build credit, it's important to understand some key differences between the two.

• Credit Cards are revolving lines of credit, which means when you pay back what you've borrowed, you can use it to borrow again. They may also have higher credit limits. This means that potential credit lenders will see you can handle a higher limit of credit when you apply for a larger loan. Credit cards also provide a grace period on purchases (assuming you paid your balance in full the prior month or didn’t have a balance) and generally have lower monthly minimum payments than BNPL loans.
• BNPL may have lower credit limits and can be a good place to begin your credit-building journey. You may use BNPL as a credit-building stepping stone and not a replacement for other types of credit.

Credit cards are likely a better choice if your main goal is to build a robust credit profile over time. Interestingly though, 62% of BNPL users think it could replace their credit cards.

Remember that BNPL options are just one of a number of payment options and can be a smart tool to keep in your personal finance toolbox.

For some people, simply paying upfront with a debit card is the easiest option.

For others, credit cards are the best option. Consider the following when deciding whether BNPL is right for you:

• If you know that you'll be able to make your BNPL payments on time, it may be a cheaper form of financing
• BNPL loans may help build your credit if you make payments on time, and can be a helpful stepping stone if you want to build your credit
• The timeline for how long you have to pay off your entire purchase can vary, so pay close attention to the terms
• Do keep in mind that unlike credit cards, BNPL options do not come with perks such as receiving cash back or earning points or miles.

The best advice is to know your habits as a consumer and use the payment method that gives you the greatest benefit while managing your ability to make a payments on-time. Always take the time to think about your options and don't feel pressured to sign up for something that doesn't seem right for you.

In considering the best-fitting financing option, it's important to do your research on BNPL. To help with weighing options, consider doing a spending analysis to determine whether or not you can afford to make a purchase in cash or if a credit card or BNPL financing option can work for you and your budget.