Whether you’re buying gas, groceries or clothes, you now have the option to defer payments over several months through installments, rather than pay in full at the time of purchase.
These Buy Now, Pay Later (BNPL) services, from firms such as Klarna and Affirm, can be tempting when money is tight: Their promise of interest-free borrowing is compelling.
Traditional 0% interest loans have been common for decades. Thousands of people take advantage of them to fund expensive home repairs or renovations.
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By enabling large expenditures without having to spend down a savings account, they help buyers afford what they need, such as a roof replacement, and help the sellers make more sales.
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However, that 0% interest comes with a well-disclosed catch: Pay off the loan by the deadline or be charged interest from the beginning of the loan.
For those organized and responsible enough to meet the deadline, these loans can be a wise financial decision: Why not keep your money working for you as long as possible?
However, failure to repay loans on schedule has resulted in financial hardship for less organized people.
It’s important to carefully consider your approach to credit before taking out any loan, but especially for loans with unfavorable terms, should you miss a deadline.
New 0% territory
The relatively new “0% loan” environment of BNPL, with shorter-term, lower-cost purchases, represents a seismic shift in the marketing and use of such loans. Often, payments must be made every week until the loan is discharged a month or two later.
As such, BNPL is frequently marketed to would-be borrowers for much smaller loans. It’s now even possible to buy lunch on a six-installment weekly repayment plan.
What’s worrying is that taking out small loans for lunch might not seem like debt. This is dangerous thinking. Anytime you borrow money that you are required to repay, regardless of whether or not interest is charged, it is debt.
Viewing it otherwise can lead you into trouble, as you may keep racking up “not debt” to the point where you can no longer afford the weekly payments.
That’s when the risky side of BNPL rears its head: As with traditional 0% loans, missing a payment can result in painful financial penalties.
A missed payment can lead to late fees of about $30, according to Consumer Reports. If you financed a $5 sandwich, for example, that’s the equivalent of 600% interest for just one late payment.
With many short-term BNPL loans, you have six opportunities to miss payments. That could turn into a very expensive sandwich.
Pros and cons of BNPL
Used responsibly, BNPL can be a good stand-in for a depleted, or never-started, emergency fund. Most financial advisers tell their clients to have a healthy emergency fund to cover unexpected expenses, such as car repairs or hospital bills.
But it can be difficult to set aside money for the “what-ifs” in life, and more than one unplanned expenditure can drain your savings quickly.
If you’re in need of emergency purchasing power, BNPL can be useful as long as you know you can keep up with the required payments.
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The problem lies in using BNPL for ordinary purchases, such as lunch, gas or groceries. As with other transactions in which cash doesn’t change hands, it’s easy to lose track of how many purchases you’ve made and how much you’ve spent.
Without careful recordkeeping, it’s all too easy to overspend, resulting in burdensome installment payments and an endangered credit score.
How to avoid financial trouble
To avoid this happening to you, make sure you understand the terms of any loan you take out:
- Beyond the interest rate, what penalties will you incur if you accidentally miss a payment?
- What other fees or costs are associated with the loans?
- Do you need the loan in the first place, or are you simply tempted to keep money in your own account as long as possible?
By asking yourself these questions before taking out a loan — BNPL or otherwise — you could save yourself significant unplanned expenses and damage to your credit score.