Buy Now, Pay Later vs. Credit

According to the Federal Reserve: credit cards are as popular as they’ve ever been. Outstanding consumer credit card debt clocked in at around $856 billion this month. But a growing number of buy now, pay later (BNPL) services have emerged on the scene, disrupting a credit market heavily reliant on maintaining the status quo.

Affirm, Afterpay, Klarna, PayPal, Sezzle, Zip – you've probably seen their advertisements. Or, more likely, you noticed a new button reading "pay in four" or "pay later" when you last bought something online. These companies market their products as safer, more-prudent alternatives to the much-maligned credit card. At a glance, though, it's not clear how the two models differ. Which, if either, is better?

Buy now, pay later services offer the same essential product as credit card companies: short-term financing for consumer goods. The primary difference between the two: with BNPL, you pay the loan back in predetermined installments over a short period, usually less than a year. With credit cards, you pay the loan back at your leisure, with the accruing interest serving as an incentive to pay back faster.

Other key differences: BNPL services usually require an upfront deposit, around 25% of the total purchase. Some services predetermine the number of installments required for the remaining balance, while others allow you to select your own payback schedule. The faster you repay, the lower the interest rate. And if you repay within a month or two, most BNPL services won't even charge interest.

That's the main selling point. No interest. Even though some credit cards offer brief introductory 0% APRs, they all begin charging interest eventually. But some BNPL services really do make it possible to borrow at 0%. The only catch: if you don't make your BNPL payments on time, you're saddled with a terrible interest rate for the remainder of the loan's term. As much as 15-20% of that purchase.

In addition to this "hook," BNPL services have several other advantages. Unlike credit cards, you won't need a hard inquiry for approval, which means there's no chance of your score dropping. In many cases, consumers are even pre-approved for BNPL. Many BNPL services won't even charge late fees. You either make your small, modest, interest-free payments on time, or you accrue a whole bunch of interest as a penalty for irresponsible borrowing.

There are serious downsides, though. Whereas credit cards can be used for virtually any cost, from gasoline to airfare to utility bil ls – even rent - you can only use BNPL services to pay at participating retailers. Interest aside, credit cards are also much more flexible with repayment, making them much more useful in an emergency. With BNPL, you're locked into their payment schedule, no matter what arises in your personal life.

The biggest downside to BNPL, though, is the lack of credit reporting.

Unlike all credit cards, most BNPL providers don't report your monthly payments to credit bureaus. But, like all creditors, they will report delinquency and default. So by engaging in this kind of borrowing, you effectively eliminate any chance of improving your credit score. As a result, BNPL is a viable option only for people with extremely good or extremely bad credit. If you have medium-quality credit, this is a simple decision: you'd be better off getting a credit card.

Compared with traditional loans, BNPL behaves more like a mortgage or auto loan than a line of credit. It's good if you hate hidden fees and enjoy fixed payment schedules with exact payments due on specific dates. It can be easier to control spending without the temptation of open-ended repayment. And if you have poor credit, BNPL services are much more eager to work with you than credit card companies.

However, their eagerness to work with subprime borrowers stems from an unsettling calculation. Statistically, people with poor credit are likely to continue whatever it was that damaged their credit. In most cases, it's overspending and missed payments: the two behaviors that provoke the worst consequences from BNPL services.

It's like…

"Yes, you really can get zero percent interest with our product, unless you do that thing you're very likely to do, at which point we'll punish you way more for that mistake than any normal credit card would."

So even if you love buy now, pay later services, consider opening a credit card for the flexibility and credit reporting it offers, at the very least. If you've had trouble qualifying for a credit card in the past, there are hundreds of secured credit cards available for those repairing or rebuilding their credit. As you research BNPL services, double-check all potential interest rates, payment schedule flexibility, retailers serviced, and credit requirements. And regardless of whether you're paying with a credit card or BNPL service, make those payments on time!