How Buy Now, Pay Later Loans Could Alter Credit | Smart Change: Personal Finances
Liz Weston, CFP®
Expanding access to credit is a laudable goal. Too many people can’t get a mortgage or an emergency loan at a reasonable rate because they can’t show a strong credit history. They may pay more for insurance or make large security deposits to obtain utilities or rent an apartment.
Recently, the three major credit bureaus announced their intention to incorporate “Buy now, pay later” plans, an extremely popular type of point-of-sale financing that until now has mostly remained outside the traditional credit ecosystem, in credit reporting.
But no one should expect purchases now, paid later to instantly open the door to better credit. If you want reliable access to the greatest number of lenders, building credit through traditional means is still the best route.
Buy now, pay later loans are growing in popularity
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If you’ve purchased something online recently, you’ve probably come across a buy now, pay later option that offered to split your purchase into a few installments. Retailers partner with lenders such as Affirm, Afterpay and Klarna to offer payment plans, which typically don’t require rigorous credit checks and may not charge interest. With the popular four installment option, for example, you pay off your balance in four equal, interest-free installments due every two weeks. Instead of charging interest, lenders get a percentage of what you spend from the retailer, similar to interchange fees charged by credit cards.
Buy now, pay later services have proliferated as the pandemic has moved much of shopping online, but plans are now available for travel and healthcare and optional at select physical retail stores. Nearly 100 million people have used the buy now, pay later option over the past year, says Liz Pagel, senior vice president of consumer lending for credit bureau TransUnion.
Like any easy credit, these plans can tempt people to overspend. Buy now, pay later loans are also largely unregulated and lack the consumer protections that cover credit and debit card purchases. Additionally, the Consumer Financial Protection Bureau is investigating how buy now, pay later lenders use the payment and purchase data they collect from customers.
Credit bureaus are still working out the details
Credit bureaus want access to this payment data, hoping they can offer traditional lenders insight into how these borrowers might handle other types of credit.
Offices are not altruistic, of course. These are private companies that want to make a profit. But in doing so, the bureaus could help expand access to credit by identifying borrowers who can manage credit among the millions of “invisibles” – people who have no credit history – as well as those who have too little information on file to generate credit scores. TransUnion’s Pagel called buy-it-now, pay-later data the biggest opportunity for financial inclusion in a generation.
How the offices will go about this is still in the works. Two of them, TransUnion and Experian, say that for now the information will not be included in regular credit reports, but lenders will be able to request it. The third bureau, Equifax, says it will feed the data into people’s credit reports.
But leading credit-reporting firm FICO is still studying buy-now-pay-later data to see how well it predicts how people might handle further credit. There’s not even agreement yet between the bureaus on whether the loans should be treated as revolving debt, like credit cards, or as installment loans, which typically last much longer.
“This is such an important question because how it’s reported makes a definite difference in its impact on the score,” says Ethan Dornhelm, vice president of scores and predictive analytics at FICO.
How You Can Build Better Credit Now
If you are currently trying to build or rebuild credityou probably don’t want to wait for those details to be ironed out.
Consider asking someone responsible for credit to add you as an authorized user to their credit card. Other options include a credit builder loan or a secured credit card from a lender that falls under the Tri-Bureau.
Credit loans, offered by credit unions or online, put the money you borrow into a savings account or certificate of deposit that you can get back after you’ve made all the monthly payments. A secured credit card usually gives you a line of credit equal to the deposit you make with the issuing bank. These aren’t instant fixes for bad credit or no credit, of course, but they are proven ways to expand your own access to credit now.
This article was written by NerdWallet and was originally published by The Associated Press.