Personal Finance | July 21, 2021

Buy Now, Pay Later: Is There a Catch?

Key Points

  • Buy Now, Pay Later options are multiplying, with over half of U.S. consumers using them.

  • Carefully consider the pros and cons of Buy Now, Pay Later before you dive in.

  • Despite the proliferation of Buy Now, Pay Later options, the time-tested rules of sound money management still hold.

Dear Carrie,

Lately every time I shop online, I see an option to pay in several installments—with no interest. I’m tempted to try it, but is there a catch?

—A Reader

Dear Reader,

This is such a timely question, and smart of you to ask before diving in! As you’ve noticed, “buy now, pay later” (BNPL) options are exploding, with retailers ranging from department stores to airlines allowing customers to pay for goods and services in installments rather than all at once. In fact, in 2021 over half of consumers have used a BNPL service such as Klarna, Afterpay or Affirm to finance their purchases.

Much of this meteoric growth is due to the huge surge in online shopping during the pandemic. And as you mention, spreading out your payments over time, free of interest (provided you pay on time), can be enticing. Taken together, it’s not at all surprising BNPL services have taken off.

But that said, there are some significant potential gotchas to think about before you give it a try. Let’s take a look at how BNPL services work—so that you can understand their pros and cons—and make an informed decision about when they may (or may not) be a good choice.

How “Buy Now, Pay Later” works

BNPL plans work like an old-fashioned layaway plan in reverse. Instead of having the merchant hold on to the item until you complete all your installment payments, you receive your goods or services up front. There’s no credit check (you’re accepted or rejected after providing only your name, address, phone number and birthdate), and you pay over time through your debit or credit card—typically in four installments separated by two weeks.

In effect, the merchant and BNPL company are giving you an interest-free mini-loan. The BNPL company charges the merchant a fee, and the merchant looks to compensate for that by increasing overall sales.

Everything works as planned if you pay on time. However, if you’re late or miss a scheduled payment, you can incur substantial late fees and possibly interest charges. In addition, late or missed payments can damage your credit.

When BNPL might make sense

Paying cash (even if over time) is cheaper than financing a purchase where you pay interest—whether that’s for a car, a refrigerator or even a pair of shoes. Given that, there are times when using a BNPL can make sense. For example, let’s say you need a new computer for work, but don’t currently have a spare $2,000 after exhausting your emergency fund. Or perhaps you unexpectedly have to purchase an expensive plane ticket to care for a family member. In these cases, making four interest-free payments every two weeks could be a godsend—and a definite plus over carrying a balance on a high-interest credit card.

It’s also true that it’s easier to qualify for a BNPL service than for a credit card. That’s probably one of the reasons many younger people who haven’t had the time to build their credit history or buyers with poor credit are more likely to use BNPL (although usage continues to climb across all ages).

How BNPL can cause problems

So what’s the catch? Actually, there are several. First, BNPL services are not currently as highly regulated by the government as credit and debit cards. Depending on the service, you likely won’t receive the same consumer protections you can get with a credit card company (for example, getting a refund for a defective product or service you never received).

Second, you may find it more difficult to stay on top of multiple purchases and payments, complicating your ability to track your spending and accurately budget. Plus, even if you make every payment on time, using BNPL services generally won’t build your credit score, which can haunt you later if you’re trying to get a home mortgage, rent an apartment, or even get a job!

But to my mind, the most serious downside of BNPL is the temptation to overspend. As behavioral economists have shown us, we humans don’t always (or even often) make the soundest financial decisions. Our emotions and biases can easily take over our common sense. Therefore, a basic tenet of behavioral economics is to make the good things easy—and the bad things hard.

BNPL (and online shopping, for that matter) can do the opposite. In fact, one study found that 45 percent of BNPL users make purchases that don’t fit in their budget.  In other words, by easing the way for impulse purchases, BNPL can make it very easy to live beyond your means—which can stand in your way of building a solid financial future.

The tried-and-true rules of money management still hold

Like credit cards or debit cards, a BNPL service is simply a financial tool. It’s not universally good or bad in all situations, but just a way for you to manage your finances. The key is for you to remain in charge, and not let the tool rule you or cause you financial harm.

To keep impulse buying (and your budget) in check, keep your goals top of mind and consider the benefits of just paying cash. If you’re disciplined about budgeting and saving, spreading out your payments over time can be helpful. But if you use BNPL to support an unsustainable lifestyle or it’s impeding your ability to fund other important goals (an emergency fund, retirement, paying down existing debt), that’s a problem. In those cases, it’s best to take a deep breath and walk away from your shopping cart.

Have a personal finance question? Email us at Carrie cannot respond to questions directly, but your topic may be considered for a future article. For Schwab account questions and general inquiries, contact Schwab.

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