What you should know about buy now, pay later plans

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Buy now, pay later (BNPL) plans have surged in popularity, offering the allure of instant gratification without the immediate financial pinch.

All you need to do is take a look at Canada’s growing consumer credit debt, as reported by Statistics Canada, to see how strong the temptation is for many to acquire what you want now, and pay for it later. According to Equifax Canada, as of the third quarter of 2023 we owe $113.4 billion in credit card debt alone.

But beneath their convenient and flexible surface, these BNPL programs harbour several pitfalls that can trap unwary consumers in a web of financial complications.

Buy now, pay later: the basics

These programs are fairly straightforward. They allow consumers to split the cost of a purchase into smaller payments -- typically four bi-weekly payments. Some programs also provide opportunities to finance purchases with monthly payments (although these repayment plans typically impose a fair amount of interest).

For example, if you use BNPL to purchase a $200 pair of shoes, you would pay the first $50 payment up front, and then another $50 would be taken out every two weeks until the remaining $150 balance was settled.

Some of the biggest BNPL companies in Canada now are Klarna, PayBright, Sezzle, and Afterpay, just to name a few.

The good

Similar to credit cards, BNPL programs often attract criticism. However, also similar to credit cards, the problem doesn’t necessarily lie with the program, but with irresponsible use. Credit cards can be excellent tools when used responsibly, but can leave you buried in debt if used irresponsibly.

Before jumping into some of the pitfalls of BNPL programs, it’s only fair to mention the upside of them.

Namely, BNPL allows you to finance an otherwise hard-to-afford purchase and split it into manageable chunks. When using the pay-in-four repayment plan, you won’t pay any interest either; just a small processing fee, which is usually less than $2.

This gives BNPL a considerable advantage compared to credit cards, which charge monthly interest fees on any balance carried over into the next billing cycle.

This can really come in handy for dealing with emergency purchases, such as buying a new laptop for work/school or replacing a broken tool that you need for your small business.

The bad

Now, let’s dive into some of the not-so-great aspects of BNPL.

They can create a debt spiral

While BNPL can certainly be helpful when used to purchase necessities, many users take advantage of programs like Klarna and PayBright to spend outside of their means on more frivolous purchases.

BNPL programs ingeniously remove the immediate financial barrier to purchases, which can lure consumers into spending more than they can afford.

This illusion of affordability can lead to impulsive buying decisions, with the cumulative effect of multiple BNPL commitments fostering a habit of overconsumption.

This can lead you into a deceptive comfort zone, where the ease of accumulating debt under multiple BNPL companies becomes a downhill slope.

Each new purchase adds another layer of financial obligation, potentially leading to a scenario where the combined monthly payments exceed the consumer’s ability to pay.

For this reason, many BNPL programs impose maximum borrowing amounts. First-time users typically aren’t given a big allowance, maybe only $200 to $300 at most. Then, as the user develops a good payment history and uses it more often, their maximum borrowing amount will increase, similar to the way a credit card line may increase.

Hidden risks and costs

While BNPL programs often advertise zero interest as their selling point, missed payments can trigger hefty fees and, in some cases, high-interest rates that escalate quickly.

Unlike traditional credit models, where terms are subject to strict regulations, BNPL agreements can catch consumers off guard with their penalty structures. This can turn an attractive short-term convenience into a long-term financial burden.

Consumer protection concerns

The BNPL sector operates in a relatively lax regulatory environment compared to traditional lending and credit services. This lack of oversight can leave consumers vulnerable to terms that are not always in their best interest.

Consumers often find themselves caught up in repayment plans that they don't fully understand, misled by the simplicity of the "pay later" promise.

The real terms, including penalties for missed payments and the specifics of interest accrual, can be obscured by marketing, leading to some unpleasant surprises down the line for some users.

How does BNPL affect your credit?

Most BNPL programs don’t perform a hard credit pull. Initially, the BNPL company may perform a “soft” credit check, just to make sure that you don’t have a bad payment history. However, soft credit checks don’t directly affect your credit score.

That being said, BNPL can affect your credit.

If you repeatedly miss your scheduled payments or become delinquent on an amount you owe and it goes to a collection agency, the BNPL program may give you a negative mark on your credit report that can hurt your score for months or years to come.

Another downside of BNPL programs is that they will never positively impact your credit, either. You can make every single payment on time, but it will never be logged on your credit report. In this area, personal loans have a distinct advantage.

What’s the best alternative to BNPL?

The best alternative to BNPL is to use a layaway program. Many stores offer to hold an item for their customers while they slowly chip away at the payments. This way, by the time you get the item, it’s already paid for.

I also suggest building an emergency savings fund, which will help you to be able to cover the cost of unexpected items, so you don’t have to worry about financing them with a credit card or BNPL program.

Tired of living cheque to cheque? Keep on reading to see my step-by-step guide to building a solid financial foundation for yourself.

Christopher Liew is a CFA Charterholder and former financial advisor. He writes personal finance tips for thousands of daily Canadian readers on his Wealth Awesome website.

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