Paying for items upfront can be tough if you are financially constrained. Buy now, pay later apps promise a flexible plan with minimal strings attached.
That sounds like a terrific way to manage cash flow, right?
Beware – these apps pose some risks. They are installment loans that can erode your budget if not managed wisely.
What Are Buy Now, Pay Later Apps?
Buy now, pay later services (BNPL services) are a new version of layaway purchases. The typical app lets you spread payments into four chunks.
Most require a down payment of 25%; then, you create an installment plan of three equal payments. For example, if you buy something for $400, you pay $100 at the start and make three $100 interest-free payments.
The due date is often every two weeks or monthly. Repayment must be made via auto-pay with a linked bank account or credit card.
These services aren't free cash, though. Instead, the respective app offers micro-installment loans that let you finances purchases.
Popular BNPL apps include:
- Zip (formerly known as Quadpay)
Tech giant Apple is even getting into the fray with their recently announced Apple Pay Later.
If you can wisely use an app to split the cost of a large purchase, they bring minimal harm. But unfortunately, studies show those who use buy now, pay later financing are stressed financially and may be unable to handle the payback.
Problematic Dangers of BNPL Services
Here are seven overlooked dangers of using these financial instruments.
It's Easy to Overspend
By their very nature, pay later services make it easier for you to spend money. For example, loan apps make qualifying easy and often have a spending limit between $50 and $1,000.
Many major retailers partner with such platforms to let you spread out your payments to make a purchase. Though convenient, this can lead to overspending.
Worse yet, Yahoo Finance reports users to tend to come from low-income or minority households. This can further erode their financial standing, especially if they're using other credit-based products.
They Can Harm Your Credit
BNPL apps sell themselves as the perfect alternative to credit cards. Unfortunately, most buy now, pay later companies only perform a soft credit check. The app won't help you boost your credit if you make timely payments.
However, if you miss payments, it can impact your creditworthiness. Many services will report overdue payments to credit bureaus, and that can result in a lower credit score.
Credit Karma reports that over 70% of people who missed at least one payment believe their credit score was negatively impacted. You also run the risk of being sent to a collection agency.
If you experience either, you could face ruinous effects on your finances.
Fees and More Fees
Buy now, pay later apps market themselves as a fee-free way to get monthly financing on a purchase. But, of course, that is only true if you don't miss payments.
Many services charge late fees once you miss a payment. For example, the Consumer Financial Protection Bureau (CFPB) reports late payments often equal $7 on an average loan of $135.
A higher late fee is reasonable if you have a higher outstanding amount. While there are often no prepayment fees, late fees alone are reason enough to second-guess using the financial tool.
This is especially true if you use multiple apps, opening you to potential fees with each company.
While admittedly small in relation to other products, fees are rarely good. Therefore, it's best to focus on establishing good spending habits if you fear you cannot make monthly payments.
Exorbitant Interest Rates
Pay later services are a fantastic way to get an interest-free short-term loan. While true if you have a good payment history, that is only if you don't miss a payment.
You may face an interest penalty if you miss a payment or don't pay off the entire amount in the given time.
The most common is deferred interest, which you may see with balance transfer credit cards, which can lead to a nasty surprise. Here is how it works.
If you have an unpaid balance, the company will charge interest on the entire amount you financed. For example, if you financed $1,000 and have a remaining $100 balance, they will charge interest on the entire $1,000, going back to the day you took the loan.
Your best option to avoid penalties is to search for plans that use terms like “no interest if paid in full within six months.” You may want to select another platform if you cannot find that wording.
Since there's minimal legal oversight, there is no standardized interest rate between buy now, pay later companies.
There's Limited Regulation
Buy now, pay later apps have grown wildly popular in recent years. Adobe reports purchases grew by 14% year over year in 2022, with revenue growing 27% in the same timeframe.
Unfortunately, there is minimal regulation over the companies. The CFPB says there is some federal and state oversight on BNPL services, but it doesn't provide much protection to consumers.
This leaves users prey to a need for common guardrails around hidden fees, disclosures, and interest rates.
It would be nice to see movement toward what more states are doing with payday loans that insulate people from predatory interest rates. But, until then, the BNPL space is a bit like the Wild West.
You May Continue a Cycle of Debt
Debt, especially consumer indebtedness, can restrict you from achieving financial goals. But, again, misusing BNPL apps can play a role in this.
Using them to make unnecessary purchases can restrict you from applying funds to other needs. You can also incur late fees or pay interest if you miss payments.
This is particularly important if you're paying off high-interest debt, as it may only further the debt cycle.
Users of pay-later apps also typically have lower credit scores. For instance, according to Yahoo Finance, 18% of BNPL users have at least one delinquency on their credit report, and nearly 70% carry a credit card balance for more than one billing cycle.
This can create further headwinds for those working to build credit.
It's wise to ensure you can make timely payments before using a micro-loan app to avoid this problem.
You're Left Twisting in The Wind
Credit cards can be terrific tools for major purchases as they offer certain protections. But, unfortunately, many of those aren't available with a buy now, pay later app.
For example, credit cards offer purchase protection. You can also dispute a charge if it's over a certain dollar amount. These can be a lifesaver if you have a problem with a recent purchase.
That is not available with BNPL companies. So added together with forced auto-pay for repayment and limited regulations, you're on your own.
If you're on edge financially, this can be particularly problematic.
Wise Alternatives To Buy Now, Pay Later Apps
Convenience is a big selling point for financial tools, especially BNPL services.
If you use them wisely, there is often little harm. However, not everyone uses them wisely. Here are five alternatives you may want to consider to make your purchase.
Saving for The Purchase
The CFPB reports the average balance on BNPL apps is $135. That isn't a significant amount of money, but if you use more than one app at a time or have more, it can become a problem.
Amassing cash for the purchase is often the best choice to make the purchase wisely. Savings can range from setting aside money from side hustles to diverting some of your savings towards a future purchase of the item.
If you can wait several months to make the purchase, saving for it is an easy way to avoid opening yourself up to unnecessary risk.
Don't Make The Purchase
An easy way to avoid using buy now, pay later apps is to avoid making the purchase, especially if you don't need it.
For example, Adobe reports that electronics purchases are a top spending category. They had sales of $202 billion in 2022, or a growth of 4% year over year.
On the other hand, home furnishings grew nearly 13% year over year in February 2023 to total over $9 billion in annual sales.
Electronics and home furnishings don't often qualify as everyday purchases. So the moral is if you can live without the product, don't make the purchase.
Instead, finding ways to save money to purchase a needed item when you have the cash is advisable.
Give Paypal's Installment Plan a Try
Not all buy now, pay later services are problematic. However, if you do a lot of online shopping, the PayPal Pay in 4 plan could be a suitable alternative for installment payments.
Like other apps, there is no hard credit inquiry, and payments are broken into four parts. You can also borrow between $30 and $1,500.
What sets the PayPal option apart is no fees and interest charges. This makes it an attractive substitute for similar apps.
You are not able to use the Pay in 4 plan with in-store purchases. Additionally, you will find no option to reschedule payments with other BNPL companies.
However, the PayPal offering could be worth trying if you need to split payments for several months. Of course, this assumes the item in question aligns with your spending limit.
Shop on Layaway
Yes, layaway is still a thing. This pay-over-time financing option was popular decades ago but is still available with some retailers. Available merchants include Amazon and Best Buy.
The key difference between layaway and BNPL is you get the item immediately with the latter. You don't get the item with layaway until you complete on-time payments.
Layaway often allows you to avoid penalties found with pay-later apps, but you may incur a cancellation or restocking fee if you cancel the plan. You also can't reschedule payments; they must be done on the terms of the given retailer.
If you don't need an item immediately, and the retailer offers it, layaway can be a legitimate way to finance a purchase.
Use a Credit Card
Credit cards are evil, right? Wrong! Credit cards can be a helpful tool for managing your finances if used wisely. They can also be a good alternative to buy now, pay later financing.
The key is to pay off your bill each month. Otherwise, you will accrue interest, which may make it challenging to pay off.
If you are disciplined, there's no reason not to use your credit card for a planned purchase. However, be careful not to apply for a new card to purchase something.
Doing so will result in a hard credit check, which may impact your credit score.
It's best to view personal loans similarly. They can be helpful, but only under the right circumstances.
Buy now, pay later loans offer an attractive way to finance purchases. If you adhere to your payment plan, you incur no interest charges or late fees, and they don't harm your credit.
It's when you miss payments that they can become dangerous. It's best to consider these offerings a line of credit or personal loan. They must be paid back and should be used sparingly.
If not, it's easy for them to spiral your finances further and take them to a place you don't want.
This article originally appeared on Wealth of Geeks.
John Schmoll is the founder of Frugal Rules, an online community he started in 2012 that is dedicated to helping people kill debt, earn more money, learn to invest, save money in all areas of life, and achieve financial freedom. He’s a former stockbroker, MBA-grad and freelance finance writer. He has been featured on Forbes, CNBC, Personal Capital, U.S. News & World Report, Prudential, Discover, MSN, Nasdaq, the Wall Street Journal, and more.