Buy now, pay later is not a cure for building credit

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Buy Now Pay Later (BNPL) products have exploded in popularity in recent years. Nearly 8.5 million consumers used BNPL in a single month (December 2021) and the industry is expected to grow 10-15 times its current size by 2025.

Buy Now, Pay Later products allow consumers to purchase items at retail with short-term loans, typically repaid by a down payment and three additional installments over a six-week period. Consumers, especially younger ones, have flocked to BNPL as a supposedly better alternative to credit cards. But is it really a better mousetrap? When it comes to helping consumers establish a credit history, the answer is no, at least for now.

Buy Now, Pay Later products are far inferior to credit cards in building a strong credit history. Young consumers who avoid credit cards might think they’re building a good credit rating with BNPL refunds, but they’re probably mistaken.

First, many buy now, pay later, lenders don’t even report payment information to the big three credit bureaus (Equifax, Experian, and TransUnion). Loans from these lenders are only reported when accounts become delinquent and are sent to debt collectors, who then report negative information. So, missing payments on a BNPL loan could definitely hurt a borrower.

Even when buying now, pay later, lenders report all their information, including on-time payments, to the credit bureaus, but not all include the information in major credit reporting files. This is the only place it could have an impact on a credit rating. Experian creates a special database for BNPL data, which doesn’t impact credit scores – although that might be a good thing for now.

Indeed, according to current credit reporting models, including BNPL data in credit reports, even positive information will only help consumers if the data is provided in a specific way – under the form of a revolving, continuous line of credit, similar to how a credit card account is reported. Unless BNPL accounts are flagged in this manner, BNPL could end up doing more harm than help, even if the borrower makes all payments on time, due to the way credit scoring algorithms work.

According to FICO, the most popular scoring provider, its credit scores are made up of the following factors:

  • Payment history (35%)
  • Amounts due, including against credit limits/initial balances (30%)
  • Length of credit history (15%)
  • New Credit (10%)
  • Types of credit used (10%)
  • VantageScore, which is the other credit scoring provider, uses similar categories.

If buy now, pay later, credit is signaled as a series of individual six-week loans that are opened and closed over a short period of time – this is how most BNPL lenders characterize their products – many of these factors will ultimately hurt a credit rating. (BPL credit should actually be considered a form of credit card, as we asked the Consumer Financial Protection Bureau. Loans would appear as relatively new accounts with very short lifespans. This would reduce the consumer score based on “new credit” In addition to these age factors, the impact of having a bunch of short-term, low-balance loans on the “amounts owing” factor is uncertain.

However, if BNPL lenders reported all of their loans to a single consumer as one revolving, open account, the product could potentially improve a consumer’s credit rating based on these same factors. In fact, there is already evidence of this. In December 2021, Equifax issued a press release touting a study concluding that “the majority of consumers in the study were helped by having an on-time BNPL business line on their credit report, with an average FICO score increase of 13 dots”. The important point is that the BNPL lender in this study declared his accounts in revolving credit, that is to say in credit card.

Credit cards are fraught with problems and can all too easily drag consumers into unmanageable debt. But the reality is that the credit reporting system and the algorithms that generate the all-important three-digit credit score rely heavily on credit card data. Until we are sure that BNPL’s statement will truly benefit consumers by being treated the same as credit cards, young people in their credit journeys might need to start their cases the old-fashioned way – with a real credit card.

Chi Chi Wu is an attorney at the National Consumer Law Center

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