Afterpay, Affirm, Yelowapp, and Klarna are just some of the firms that provide buy now, pay later (BNPL) services, and they're only getting more popular. If it hasn't already, the way you use these services might have an impact on your credit score in the near future. According to statistics from Salesforce, BNPL usage in 2021 increased by 29% over the previous year during Cyber Week (November 22-29), with moreover $22 billion in worldwide transactions funded.
Paying for products using a BNPL plan (also known as a point-of-sale loan) allows customers to spread out the cost of their purchases over a short period of time, generally four weeks. Longer-term financing for larger items is also available from some BNPL firms. When it comes to current credit cards and old-fashioned layaway programs, BNPL plans are a modern-day hybrid. They allow consumers to acquire a product without paying the whole amount ahead.
BNPL and credit scoring
As of now, the credit bureaus aren't aware of a large majority of BNPL programs. It's rare for Affirm to share some of its long-term goals with Experian, but it's not unheard of.
Most BNPL participants saw a 13-point gain in their FICO score as a result of on-time payments, according to Equifax, which ran the pilot program. Individuals with "thin" credit files (two or fewer tradelines) or "young" credit files had the greatest improvement (21 points) (a credit history shorter than 24 months).
I support the inclusion of "alternative" credit measures in customers' credit reports. For a good reason, I've put the word "alternative" in quotation marks. Streaming services, mobile phone subscriptions, rent, and utility bills are all considered "alternatives" by the credit reporting industry since they haven't previously been factored into credit scores. However, I believe that the basics are very much in common. Debt repayments on a monthly basis include credit card and vehicle loans as well as home mortgages They should be included in a consumer's credit rating.
BNPL plans should be taken into account when calculating credit ratings, in my opinion, but only if done correctly. There are still a few minor details to iron out.
How “buy now, pay later” financing affects credit score
When you use a credit card to make a purchase, your credit score is affected in a similar way. An inquiry into your credit history is no longer required when using newer systems that do not require you to fill out an application.
In most cases, providing your Social Security number (either in its whole or the last four digits) implies that your credit score and history will be checked in order to determine whether or not your application is approved for a loan or new credit line.
Inquiries, in case you forgot, account for 10% of your credit score. To calculate your credit score, BNPL does not need a rigorous inquiry into your credit history. Because BNPL firms do not examine your credit history, there will be no mark on your credit report as a result.
This does not imply that BNPL firms do not do background checks to establish if you are a suitable candidate for their services. Make sure you have enough money in your monthly payment plan to cover each installment; if you're frequently late or do not have enough, many BNPL firms will prevent you from utilizing their services in the future if you don't pay on time.
Payment plans that allow you to fill out a formal loan application, such as auto loans, personal loans, and other installment plans, may have an impact on your credit score as well. When setting up a payment plan, be sure to read the tiny language and inquire if a hard credit check will be performed.
The challenges of adding BNPL to credit scoring
If you routinely create new credit accounts, you may want to think again about doing so. Too many harsh queries might imply a precarious financial condition, thus they should be avoided at all costs. A two-year period should not see more than five or six hard inquiries. Buy now pay later users, on the other hand, may be exempt from this rule due to the nature of their inquiries. However, the age of a consumer's accounts is also taken into consideration by credit rating algorithms (in terms of the average age of those accounts as well as how recently the newest was opened). Every BNPL proposal might have an unintentional negative impact on credit ratings if it reduces the average age of credit history.
BNPL's status as an installment loan or a line of credit might also have an impact. How will credit use be measured if it's a line of credit and the impact of buy now pay later on credit score? When it comes to credit cards, one of the most important factors in determining your credit score is the ratio of available credit being used compared to the available credit limit. Lenders view you as unsafe if you're spending $4,500 out of a $5,000 credit limit since you're near maxing out the card, which is a red flag for them.
In contrast to a broader, open-ended line of credit, BNPL plans are often underwritten on an individual transaction basis. If your "credit limit" is $2,495 and you're financing a $2,495 bike with 43 installments of $58 each, your credit usage ratio will be elevated for quite some time (at least for that transaction). Even if individuals follow up with their monthly financial obligations, this might unwittingly harm their credit ratings.
Finally, would any bad information (such as late payments) be included in the public record? – In the past, the credit bureaus received both good and negative information, but current credit scoring methods, such as Experian Boost, only include positive data.
How to improve your credit score right now
Buy now, pay later loans might take months or even years to appear on credit records. It is possible to develop credit now, though, if you use a product that reports to the credit reporting agencies.
The following are a few possibilities:
- Status of the authorized user: Acquiring access to someone else's credit history by becoming an "approved user" of their account. If a credit card is used by someone who is authorized, that person is not obligated to pay back that money.
- Loans for credit-building: In order to get the funds, you must first pay back your loan. Make sure you can afford the costs and select one that reports to all three credit agencies if you go this way.
- PIN-protected charge cards If you don't have enough money to put down a deposit, your credit limit will be that amount. Secured credit cards are preferable since they "graduate" into standard cards after a set number of on-time payments and repay your investment.
- Credit card alternatives: This type of card uses atypical data in underwriting choices, such as income, job, and bank information, to get you on the credit radar.
- Cards for retail stores: There are a number of credit cards that have less stringent requirements and depend more heavily on data from outside the credit ecosystem. Check your finances before signing on the dotted line, as interest rates might be hefty.
Why Is It Important To Improve Your Credit Score?
Using your credit score, lenders can figure out how much money you can afford to repay and other considerations for lending to you, such as the interest rate you'll qualify for. BNPL services may not need a high credit score for smaller purchases, but good credit history is necessary when applying for a home loan. This type of purchase necessitates a high FICO® credit score, which weighs factors such as your current debt, payment history, age of credit, number of credit cards you have, and the mix of cards you have.
Make sure you pay your bills on time, limit the amount of debt you take on, and start developing a good credit history as soon as possible.
While it's doubtful that buy-now, pay-later programs would help you establish credit, the way major credit bureaus and lenders report on these programs might alter if they grow more widespread. Missed BNPL payments, on the other hand, may be reported to a credit bureau, lowering your score.
It's important for consumers to make sensible purchases and keep up with their payments in order to safeguard their credit ratings while using BNPL lenders.