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What is Afterpay, Klarna and Affirm? | How “Buy Now, Pay Later” Impacts Your Credit

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Highlights:

  • Buy now, pay later (BNPL) plans are payment options for online shopping that divide your purchases into multiple payments over a certain period of time.
  • In December 2021, Equifax became the first consumer reporting agency (CRA) to formalize a standard process for reporting BNPL services on credit reports.
  • When paid in full and on time, some BNPL services can be beneficial for people with thin or young credit files who are looking to establish a credit history.

What is Afterpay? How does Afterpay work?

*Equifax is not affiliated with nor endorsing Afterpay, Klarna or Affirm in this article.

Afterpay is one of the many examples of financial technology companies offering “buy now, pay later” (BNPL) services to online shoppers. As the name suggests, these payment plans allow users to purchase items right away, but then make payments on the purchase over time. In most cases, the payment plan is split into four equal payments. The first payment is paid at purchase and the remaining three payments are withdrawn every two weeks from the debit or credit card linked to your BNPL account.

Afterpay, Klarna, Affirm and other BNPL payment options can make it easier to buy online. But it's important to know how BNPL services could affect your credit report and credit score.

How do buy now, pay later services work?

BNPL services (sometimes called BNPL loans or interest-free financing) divide your online purchases into multiple payments over an extended period, rather than a single purchase. When you use BNPL services, you generally submit the first payment at checkout. Then, you get billed for the remaining payments in equal, interest-free amounts until the purchase is paid in full.

Buy now, pay later services may be available on items ranging in price from less than $100 to as much as several thousand dollars. Shoppers are generally given the option to apply for BNPL services at checkout.

Unlike other types of financing options, most BNPL companies don't require a hard inquiry into a person's credit history, and many may not require a credit check at all. Instead, servicers may simply collect a shopper's name, phone number and other identifying information along with a credit or debit card number.

Depending on which company you use, if you miss a payment you incur late fees. Afterpay, for example, does not charge interest on repayments, but there are late fees for users who do not pay on time.

How could Afterpay or other buy now, pay later services affect your credit?

The answer will depend heavily on the BNPL servicer you choose to apply for.

Many BNPL plans only run a soft inquiry on your credit report to determine eligibility (or do not run a credit check at all). So, in these cases, your credit report and credit score are unlikely to be impacted simply by applying for a BNPL service. However, every BNPL servicer is different. Always carefully review the terms of any BNPL service before applying.

When it comes to reporting, some BNPL services don't report payment information to consumer reporting agencies or may only report information to a select number of CRAs. However, the way BNPL payments are reported is still developing.

Equifax became the first CRA to formalize a standard process for reporting BNPL services on credit reports. A study, which compiled anonymized consumer data from a BNPL provider, concluded that consumers who paid off their loans on time were helped by having BNPL payments included in their credit file. Equifax encourages BNPL providers to report credit information, in an effort to reward consumers for positive repayment habits.

Can buy now, pay later services help you build credit?

When included on a person's credit report, BNPL loans can be beneficial for people with thin or young credit files who are looking to establish a credit history. A thin credit file consists of two or fewer lines of credit, while a young file means that the user's credit history is no more than two years old. A lack of credit history may lead to a lower credit score. So, it can be difficult for people in these situations to qualify for credit cards or traditional loans.

That's where BNPL services may help. The average user in the Equifax study saw an average FICO® Score increase of 13 points with the addition of on-time BNPL usage. For those with thin or young credit files, that number jumped up to 21 points.

There are also benefits for users who may need to improve their credit score due to missed payments or other negative information on their credit report. BNPL plans are typically easier to qualify for than other lines of credit. So, securing a BNPL loan and making on-time payments may help build a history of positive credit behavior.

There are some potential downsides to BNPL when it comes to credit. The loans are usually repaid within a few weeks for smaller purchases, which may not help if you are looking to lengthen your credit history. The average age of your accounts and the length of time since you last opened a new account are both typically factored in your credit score. The short-term nature of BNPL plans also means that the loan could be completely paid off by the time it makes it onto your credit report, as there is often a delay in when information is reported.

What are some potential impacts of buy now, pay later services?

Under the right circumstances, BNPL plans can be useful tools to online shoppers. But, like all loans, they aren't without their risks. Shoppers may be excited to access previously unachievable purchases and end up spending more than they can afford to pay back. Additionally, some BNPL services may institute late fees and high interest rates on payments that aren't made on time.

As with any other loan or debt, be sure that you're able to pay back your purchase in full before signing up for a BNPL loan. Just as the plans can help your credit if you pay on time, they can also hurt your score if you miss payments and end up racking up more debt in late fees and interest.

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