Is buy now pay later a type of loan?

Buy now pay later quickly became a popular way to finance everyday shopping and large purchases after a couple of providers started offering the service in the UK in 2019. Now it’s available on almost any online shop and there are increasing calls for BNPL to be regulated by the Financial Conduct Authority (FCA) to protect and encourage fair treatment of customers.

Because buy now pay later schemes are interest-free for the first three or six months, it’s easy for customers to get carried away, and the service can encourage overspending. While the smaller payments may seem tempting at first, if you use the service several times, those small payments add up quickly and can suddenly cause customers to be financially overcommitted. It also means that consumers don’t necessarily realise that buy now pay later is a type of borrowing and that missing repayments can cause money problems and make credit harder to obtain in the future.

How does BNPL work?

When you want to make a purchase but can’t afford the full balance in one lump sum, buy now pay later offers a way to defer the payments for typically either 30 or 90 days. In order to do this, they run a hard search on your credit file, which leaves a footprint that other lenders can see, so that they can assess your creditworthiness. This is a common check that most lenders conduct when you apply for any type of credit. The potential issue with BNPL is that consumers use the product frequently, which results in several hard searches being recorded, compared to perhaps one hard search in a couple of years for a credit card or one or two searches throughout the year for a same day loan. If you are approved, the BNPL provider covers the cost of your shopping, and you then make the required payments on your next payday or over your next three paydays.

Having hard searches on your credit file is not necessarily a bad thing but it does highlight how frequently you apply for credit which may imply that you rely on borrowing to meet your monthly expenses or that a significant portion of your disposable income is already allocated to loan repayments. These are things that may be viewed negatively by prospective lenders so if you don’t need to borrow, it’s usually best not to, and you should try to avoid using credit like BNPL every time you shop.

Is BNPL a loan?

To put it simply: yes. Buy now pay later schemes are loans as you borrow money from a lender and then you repay that lender. Even though there is usually no interest charged, at least to start with, buy now pay later is considered a loan and your credit file will reflect this accordingly. You can also be charged late payment fees for missing your repayments so it’s important that you take every normal consideration when applying for BNPL as you would take when applying for any online loans. This includes:

• Reviewing the necessity of the purchase to ensure it can’t wait until you have the money saved and can afford the expense without borrowing
• Making sure you can afford the repayments over the full loan term
• Checking your budget or calendar for any upcoming irregular payments that may prevent you from meeting your agreed repayments on time

How to manage your BNPL repayments

Keeping track of your buy now pay later payments is the same as tracking normal loan repayments. You need to remain aware of the total amount due each month and how many repayments you have to make. It may be easier if you have a second bank account as you can transfer the total amount due throughout the month into that account when you get paid, and as long as your direct debits or standing orders are set up from that account, you can relax knowing all your repayments will be met on time. This also reduces the risk of overspending before your repayments fall due. If you have a lot of buy now pay later repayments currently, it might be a good idea to avoid taking out any new agreements until your current ones are repaid so you can reset your budget. This might also give you the opportunity to start putting some cash into savings so you can be less reliant on credit in future.

Buy now pay later can be a great tool for spreading the costs of expensive but essential purchases like a new oven or a new boiler. These are things that we can’t really live without but may cause cashflow shortfall if we paid it out of one paycheck. In these instances, splitting the balance over a few months with an interest-free loan is a responsible way to use credit. Credit usage can become irresponsible where it leads to overcommitment and financial difficulty. While you may be certain you can afford the repayments now, taking out credit for unnecessary purchases can reduce the credit available when an actual emergency arises. It also commits your future income before you’ve even earned it.

Credit is a great way to help manage your money effectively and meet unexpected expenses, but it must be used sensibly and with a full understanding of the exact agreement you are signing. BNPL can be a helpful way to borrow but not if it encourages you to overspend and cause potential financial difficulties.