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How Buy Now Pay Later Services Affect Your Credit Score

“Buy now pay later” apps, otherwise known as point-of-sale loans, are becoming a popular option for consumers to make purchases and pay over time without incurring any interest. It almost seems too good to be true: You’re shopping online, eyeing a pair of shoes that are just a little more than you’d like to spend right now. A small icon next to the price gives you the best possible news—you don’t have to pay all that money right now. You can pay for it in installments that are much more affordable.

The truth is while you may recognize names like Affirm, Afterpay, and Klarna (and services like them), understanding how they work and how to use them responsibly.

How pay later apps work

There are certain terms you must abide by to use these services; making your installment payments on-time, for example. They are in no way consequence-free loans, but these services aren’t necessarily a dangerous scam, either. In practice, installment payment services operate a lot like credit cards or store financing. When you make a purchase and choose to use the service, it essentially pays the full price of your purchase to the store or merchant. You then pay regular installments to the service, not the merchant, from a credit card, debit card, or bank account until you’ve repaid the full cost of your purchase.

Your payments will depend on the service you use, though many rely on a system in which the purchase price is broken into four payments made over about six weeks. With this system, your first payment is due at the time of purchase, and then you have a payment due every two weeks until all three remaining payments are made. For the most part, if you make all your payments on time, you’ll pay no fees or interest.

If you’re not paying fees or interest, you may be thinking, how do these services make money? Mainly, services such as Affirm, Afterpay, and Klarna make money from the online stores you’re shopping from. They charge retail partners a fee, and in return, those retailers tend to see higher sales and larger purchases from people using the services to make their online splurges more affordable. Unlike lenders or credit card companies, the bulk of these companies’ earnings are coming from other companies, not from borrowers, though some do take in a small amount of money from late fees and interest payments.

How some “buy now pay later” apps could decrease your credit score

Depending on your buy now pay later provider, taking out a loan can either increase, decrease, or have no impact at all on your credit score. Some of the most popular point-of-sale loan providers like AfterPay, Affirm, and Klarna report some loans to the credit bureaus while others don’t.

Affirm is one buy now pay later provider that does report information to Experian on some loans. It doesn’t report loans with a 0% APR and four biweekly payments or loans where people were given the option of a three-month payment term with 0% APR. For other Affirm loans, the entire loan history is reported to Experian. This means that both positive and negative payment history will be reported to only Experian and not the other credit bureaus. Your payment history, the amount of credit you’ve used, the length of time you’ve had the credit and any late payments will all be reported to Experian.

If you default on your Affirm loan or make late payments, you risk decreasing your credit score. But your credit score could also take a hit even if you’re paying your point-of-sale loan on time.

There are a few reasons why a loan could hurt your score. For starters, there are many factors that make up your credit score, and your score can go down even if you pay your bills on time, if there are other areas that are lacking.

Here are the five factors that make up your FICO score:
  • Payment history (35%): Whether you’ve paid past credit accounts on time
  • Amounts owed (30%): The total amount of credit and loans you’re using compared to your total credit limit, also known as your utilization rate
  • Length of credit history (15%): The length of time you’ve had credit
  • New credit (10%): How often you apply for and open new accounts
  • Credit mix (10%): The variety of credit products you have, including credit cards, installment loans, finance company accounts, mortgage loans, and so on
  • Some of the factors that determine your credit history are the average age of your accounts, the age of your oldest account, and how long it’s been since you opened an account.

Every purchase you make with a buy now pay later app is considered a separate account on your credit report that gets closed once you pay off the balance. Since these loans are short-term (generally six weeks), they run the risk of bringing down the average age of your credit history, especially if you’re a regular borrower. Because 15% of your FICO credit score is determined by the length of your credit history, repeatedly taking out point-of-sale loans can decrease your credit score since it lowers the average age of your accounts.

Affirm addresses how its loans can impact consumers credit scores in its help section, noting that how much credit you’ve used, how long you’ve had credit, making late payments and your payment history with Affirm could affect your score.

So, should you try a buy now pay later app?

It’s up to you to decide whether any of these services is right for you. Before you sign up, you should consider a few things.

Firstly, why do you need to break your purchase up into installments? If it’s because you cannot truly afford the item, you may want to rethink your purchase and practice budgeting so you can be sure your purchases are within your range of affordability.

Second, take a look at any debt you may already have. If you are working to reduce your credit card debt or want to avoid that high-interest debt altogether, a buy now pay later service might be the right alternative for you. Having a credit card and using one of these services is close enough to the same thing that you may not want to do both. Using a credit card to fund installment payments can just land you in more debt. Affirm, Afterpay, and Klarna are presented as alternatives to credit cards; those wary of landing in deep credit card debt, or those trying to climb out of it, can still enjoy the convenience and budgeting of buying now and paying later, without the same fees and compound interest.

“Buy now pay later apps are tempting due to its method of allowing consumers to purchase items even if they cannot afford the total price at the moment. However, they should be used in moderation so as to not damage your finances or credit score”, said Bernice White, South Bay Credit Union, CLO.

If you do want to wade into the world of buying now and paying later, do your research and try to pick one service that is available at many retailers you know and love. All services place individualized limits on purchase amounts based on a number of factors, including shopping and spending habits. New users may have a lower limit, but most services increase that limit for repeat users who make on-time payments. If you’re a big spender, sticking with one service will make it easier for you to make bigger purchases responsibly.