Written By: Mark Buttgereit   ~   Reading Time: ~10 minutes

Who hasn’t heard of them? Klarna, Laybuy, Clearpay, Zip, … If you’ve tried to pay for an online purchase lately, some of these names might seem familiar to you. Buy now, pay later has become a thing. But what are these companies really about? How do they work? And what are the dangers of buying now and paying later? Let’s find out.

…and many more

The basic idea.

‘Buy now, pay later’ – also known as BNPL – hasn’t changed the ‘buy now’ part of the equation. You simply go about your online purchases in the same way as you always have – until you arrive at your payment options, where you find the additional option of an external company (most likely one of the five named above).

Figure 1: The BNPL circle (reference)

Now, the ‘pay later’ part of BNPL can take on different forms. Depending on the service provider used, you may choose to delay the entire bill or only part of it (some of the providers also function as simple payment processors, but that’s not what we’re talking about here). The delayed payment may then be paid off in full or in a clutch of equally sized regular installments. Most often the first installment is paid at the point of purchase (as is the case with Klarna). However, all of these services have one thing in common. They’re entirely ‘interest-free’ (not really, as we’ll see later), which begs the question ‘How do these firms generate revenues?’ The answer to this question is three-fold: For most of these firms, the greatest part of revenues is generated directly through the retailers implementing the service on their websites. Typically, this is a given percentage of the purchase price, usually ranging from 3.29-5.99% (see for yourself for Klarna and here).

Figure 2: Revenues of BNPL firms, split up by category (reference)

The second source of turnover consists of other consumer fees: These may take on the form of

  • establishment and redraw fees,
  • regular account keeping or administration fees,
  • payment processing fees OR
  • missed payment fees (which are enumerated separately) and/or account closure fees.

Lastly, and in this case also the least, the third source of revenue generation is based in the fact that all of these companies effectively are providers of short-term interest-free loans: If the borrower can’t make the payments in time, interest has to be paid on the furtherly delayed payments. These may take on values ranging from $4.99 up to $15 , depending on the provider.

And this is where a great part of the criticism begins: Critics claim that the BNPL firms simply aren’t transparent enough about what happens when you default on your payments. One of these aspects includes how a default affects…

Your credit score.

If I do choose to use BNPL services, are these companies able to access or influence my credit score? Well, the answer to this question is not quite as simple as it seems. Let’s see what one of the big players have to say:

‘…we may perform a soft credit check. This type of check will not impact your credit score or show up as an inquiry on your credit report. When you submit an application for monthly financing, a credit check will be performed during which Klarna will contact the credit bureaus. This will show up as an inquiry on your credit report.’

-Klarna, ‘Does Klarna perform a credit check?

However, what happens in the case of default remains fairly unclear. Not only are the consequences unclear, but the terms of contract vary from one provider to another. So, what do we have to know in this jungle of confusion? There is one essential question we have to answer: Are the loans reported to credit bureaus? (Even this simple question can be very difficult to answer). One thing, however, remains clear, there have been numerous reports of credit ratings being downgraded as a consequence of defaulting on BNPL payments (see here).

In conclusion, we can say that none of the BNPL service providers can affect your credit score positively. As of yet they don’t – This doesn’t mean that they won’t in the future.

Some effects.

When taking a look at the application, it turns out that BNPL services are highly popular with retailers for the simple fact that the usage of these services on average cause higher purchase volumes, which simply means more business for the retailers. In fact, most BNPL firms market their services as significant growth driver of retail revenue.

Figure 3: Advertising more revenue for retailers (reference)

With the average customer  (on the borrower side of the business) being within the age of 20-40, we can see very clearly how pervasive  – might we say how addicitive – the usage of BNPL has become within the younger age groups. However, its greatest danger is apparent: Financial overcommitment.

In November 2018, the Australian Securities and Investments Commission (ASIC) released its findings regarding the BNPL market and was able to establish five key findings:

#1 buy now pay later is a rapidly growing industry

#2 The buy now pay later industry is diverse and evolving

#3 Some buy now pay later arrangements result in the price of goods being inflated

#4 Many buy now pay later users are relatively young consumers

#5 Buy now pay later arrangements have influenced the spending habits of some consumers

Now, why do customers’ spending habits change and especially why does spending tend to increase, when using BNPL? The answer to this question is a fundamentally psychological one…

The psychology of paying later

Let’s start off with a situation from our daily lives: We go to a store and choose to buy something, we get to the till and have to decide the following: Do I pay with cash or do I pay with my credit card? An essential question to posit within this experiment is which of the two feels worse? Paying with cash or with your credit card? I’m pretty sure you know the answer to this: Cash. But why?

This underlying phenomenon is termed as ‘the pain of paying’: The more closely we associate a payment with the adherent consumption, the worse it feels. In this regard, not only the timing of a payment, but also the method of payment is relevant in understanding how our perception of payments is formed.

In the case of BNPL, the ‘letting go of money’ is very disassociated with the joyful rush of purchasing. Not only is the payment delayed, but also we’re not giving physical cash out of our hands, when using BNPL. This is why people tend to purchase more and more often when using BNPL services.

Some guidelines.

When deciding whether to make use of BNPL services, we think two basic questions have to be answered very clearly:

  1. ‘Do I really need this now?’

To be clear, these types of services clearly are very useful when used for necessary purchases, for which the liquidity simply isn’t available for the moment. The main issue really is that we tend to get carried away and simply overestimate our future ability to back the loan.

  1. ‘Can I really afford this in the very near future?’

In the words of Dan Lane ‘If you can’t afford the product today – why do you think you could afford it in 30, 60 or 90 days time?’

Now, of course, it’s not all doom and gloom. You can also leverage BNPL services to your advantage. Let’s say there’s a long-term purchase you want to make and it happens to be reduced. However, your current liquidity doesn’t allow for that purchase – maybe it’s a fairly large purchase. In this case you may actually save a good deal of cash and use BNPL to your advantage.

There’s one aspect, however, that is not challengeable: You have to think about your installment payments as part of your monthly bill. Treat them just like your rental, gas electricity, mortgage or car loan payments and the chance of not making the worst decisions decreased dramatically.

Looking forward.

As it turns out, the emergence of BNPL companies most likely is a result  of an ultra-low interest environment. In effect, BNPL firms are providers of short-term interest-free loans. Historical lows of short-term interest rates for most developed economies put pressure on the traditional model of universal banking, due to its sensitivity to credit spreads.

In niches, in which established business models have decreased in their effectiveness, a breeding ground for new market entrants comes into existence. Two questions, however, remain: Is the BNPL model able to persist in higher interest-rate environments? And is regulation keeping pace or are we seeing another run-up of laissez-faire?

The rapid rise of ‘Buy now, pay later’’, Rebecca Wearn, 26. January 2020, BBC News

laybuy homepage’, laybuy

Klarna homepage’, Klarna

Clearpay homepage’, Clearpay

zippay homepage’, zip pay

Review of buy now pay later arrangements’, Australian Investment and Securities Commission, November 2018

The Pain of Paying: The Psychology of Money’, Dan Ariely for Duke University

‘It’s like the wild west’: is the latest buy now pay later service just rebranded debt?’, Katie Cunningham, 7. February 2020, The Guardian

How Zip pay works, and why the extra cost of ‘buy now, pay later’ is still enticing’, Saurav Dutta, Harjinder Singh & Nigar Sultana, 18. February 2019, SmartCompany

Buy Now Pay Later Stores’, Shopping Kim

The Klarna Business Model – How Does Klarna Make Money?’, 20. November 2019, ProductMint

Can shopping with Klarna, Clearpay or Laybuy hurt your credit score?’, Reena Sewraz, 23 January 2020

Does ‘Buy Now, Pay Later’ Financing Affect Your Credit?’, Latoya Irby, 31 January 2020, the balance

Why buy now, pay later credit schemes could damage your credit score’, Caroline Bloor, 15 January 2020, goodhousekeeping