What to Consider Before Buying Now and Paying Later

We are in the full swing of summer! At the Gym, we know this is the peak season for all things outdoors. It's usually the case that we all let off the gas on our financial road trip. Purchases are happening, trips are being planned and enjoyed, weddings are back on schedule, so it’s easy to get lost in the midst of all these events happening to bank accounts and credit cards. 

It is no wonder, if you’ve been online shopping recently, that buy now, pay later companies have such a compelling offer. They take the chaos around monthly bills, getting approved or denied for a line of credit, or doing your best to just stay afloat and present you this opportunity to have your cake (or furniture) and eat it too! Companies like Afterpay, Affirm, Klarna, Paypal, Sezzle, and their many retail partners are moving in the direction to further remove the friction around payments. 

Now, this is not to say all of this is bad. Removing as much friction as possible from the buying process leaves you a happy customer, has the business closing on more transactions, and keeps the ball rolling. However, all of us need to take a step back and assess all the implications associated with going through with a buy now, pay later company to make our purchases, especially when it comes to your monthly budget and your finances as a whole.

Setting the stage

The deal with these companies is pretty straightforward: Consumers get the product immediately without paying anything upfront. All they have to do is commit to a weekly (or monthly) payment plan, states Scalefast, an eCommerce solutions company. This type of setup isn’t anything new. For example, if you go through a promotional period with a store credit card, you’ll be able to enjoy a period of 0% interest if you repay your balance in full after a defined period of time. Best Buy is a great example of this and I’m sure you’ve come across a couple of these promotions from your favorite stores. You can even go as far back as layaway programs where the store would hold the item or items you wished to take home, set up monthly installments, and only until after you paid the full amount would you take the items home. 

But layaway programs quickly fell out of favor especially when banks and other financing companies started to offer credit cards. As an NPR article notes,“credit cards and the immediate gratification of taking your purchase home changed things.” Buy now, pay later companies said, “Hey! Why don’t we just combine the two and continue this legacy of removing more and more frictions, or moments of pause, from the buying process?” This has attracted quite a number of fintech companies and now you have a competitive space that pits newcomers like Affirm, Klarna, Sezzle and Afterpay with well-established companies like PayPal. Reports in July of 2021 mentioned that Apple, in their continued partnership with Goldman Sachs, are looking to enter this space as well. 

Great! So what’s the catch? 

One could argue that these companies are making purchasing decisions a little too easy for the average consumer. Companies make a lot of investments to ensure that your overall experience with their store, site, service, or product is as frictionless as possible. The result of this is that you are left with fewer things to hold you back from buying that good or service. Adding a little more friction to your finances is what allows you to stick to your spending goal and keep you on track to save for the goals you wanted to achieve. For example, it is one of the main reasons why we at The Financial Gym recommend that you separate out your Emergency Fund to a high yield savings account to add some friction to accessing your Emergency Fund instead of treating it as an extension of your checking account or normal cash flow. You can take a look at some of the B.F.F (Best Financial Friend) approved list of high yield savings accounts that we recommend here! 

Ultimately, a frictionless experience makes it easier to lose track of what your personal budget would give you permission to purchase after all other factors are considered. This is a common practice in other industries as well. Auto dealerships, for example, talk to you in terms of monthly car payments instead of the total sticker price of a car. Why? Ask yourself: is it easier to plan and picture $350 a month or $35,000 upfront?

Buy now, pay later companies fall into this gray category where they aren’t viewed publicly as a traditional lender but act like it in many ways. For example, if you were to miss out on a payment, you would be subject to fees. Klarna will assess “a late fee of up to $7.00 (that) will be added to your outstanding balance if you paid with ‘Pay in 4 installments’.” Additionally, “Late fees will never exceed 25% of your order value.” Afterpay has this to say regarding late fees: “There are no finance charges or interest associated with this Agreement. However, if an Installment Payment is not paid on or prior to the due date specified in the Final Payment Schedule and remains unpaid for a period of ten (10) days after the due date...the Late Fee ...will be imposed, up to a maximum of $8.00.” Lastly, Affirm states that: “We don’t charge any fees. That means no late fees, no prepayment fees, no annual fees, and no fees to open or close your account. Depending on the size of your purchase and where you’re shopping, your payment plan may include interest.” Remind yourself, when you’re at checkout, that even though they present themselves as alternatives to traditional financing options, the standard language and fee infrastructure is still part of their language and how they operate.

Let’s assume that they are a more traditional financing company than not, so naturally you would ask how this would affect your credit score. Klarna, for example, states that when you use their split into 4 interest-free payments that they run what is called a soft credit check. A soft credit check or soft credit pull is when you or someone you authorize checks your credit report. Experian, one of the 3 credit reporting agencies, states, “Soft inquiries don't impact your credit scores because they aren't attached to a specific application for credit.” Affirm takes a slightly different take on affecting your credit score. They state, “If you decide to buy with Affirm, these things may affect your credit score: making a purchase with Affirm, your payment history with Affirm, how much credit you've used, and how long you’ve had credit.” The big takeaway here is that even though these companies function, copy, and borrow ideas from one another, their credit approval systems are different and can have implications down the line whether it be on your credit score or ultimately your budget!