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Buy now, pay later? Stay safe

In the summer of 2020, amid the fear and uncertainty surrounding the pandemic, Amber Cole of Colorado Springs, Colorado turned to retail therapy. She scoured the Lululemon website to find trendy activewear like t-shirts and leggings for $50 to $130.

Cole, 33, saw a tempting option to pay for his purchases. After entering some information, she could buy the clothes in four installments spread over six weeks. This way, a $50 T-shirt grew to a payment of $12.50; a $130 pair of leggings was only $32.50. The best part: She could get the items before she finished the payments, and she didn’t have to pay interest.

This frictionless option to pay for items in chunks – called “buy now, pay later” – was popularized by Afterpay, an Australia-based fintech company founded in 2014. Throughout the pandemic, as As people hunkered down at home and sought to fill the voids with material goods, installment payment plans gained traction. Afterpay, which Square acquired for $29 billion in 2020, has spawned imitators including Affirm, Klarna, and Fingerhut. This month, Apple announced that it would offer a similar program.

Although financing programs offer benefits such as interest-free payments, there are potential dangers. The rule of thumb for financial security is to be aware of your budget and control your spending, say personal finance experts. But “buy now, pay later” schemes seem aimed at tricking people into thinking a product is cheaper than it really is and losing control of their spending, critics said.

In December, the Consumer Financial Protection Bureau launched an investigation into these programs, fearing that people could go into debt with multiple purchases.

“They can be helpful to consumers in the sense that they don’t earn interest if paid on time, but consumers may end up buying more than they expected,” said Laura Udis, program manager at the bureau.

Cole fell into this trap. By using the installment payment plans, she said, she increased her average purchases by $200 to $400 per order over time. Packages appeared on his doorstep every day. His biggest regret was a $600 rug from Anthropologie (split into four $150 installments).

Cole soon fell behind in paying his regular bills. She eventually told her husband the truth and, to catch up on payments, got a job at a bakery and sold some of her impulse buys on eBay. A few months ago, she closed her Afterpay account.

“I had a beautiful closet full of beautiful clothes, handbags and shoes,” she said. “But it’s also filled with shame, guilt and regret.”

Buy now, pay later has become impossible to ignore. Here’s what you need to know.

How it works? It depends

In general, buy now, pay later programs from companies like Afterpay, Affirm, Klarna, and Zip look the same, but there are some important differences.

These are usually short-term loans that allow you to pay for an item in four installments (or less) over a period of around six weeks. After a consumer provides certain information, such as a name and social security number, businesses typically make a light credit application. From there, you make a deposit, which is 25% of the total cost of the product, and invoices for the remaining three payments come in every two weeks.

The loans are interest-free for individuals, largely because the retailer pays a higher transaction fee – 4%, roughly double the typical transaction fees incurred by a credit card company. The benefit to the retailer is that installment plans can persuade people to buy things they wouldn’t otherwise buy, said Jared Wiesel, an executive at Revenue Analytics, a pricing and sales consultancy.

What happens when you miss a payment? This is where the differences appear. Afterpay charges a flat $8 late fee approximately 10 days after a missed payment. Affirm doesn’t charge a fee, but says late payments can affect your credit score, which could hurt your chances of getting another loan.

This was a major drawback pointed out by John Cabell, director of banking and payments research at JD Power, who recently published a study on problems with payment programs.

“It doesn’t help you build your credit like a credit card does, but it can definitely hurt your credit if you don’t make your payments on time,” he said.

Returns have also been a source of confusion among consumers who have used buy now, pay later financing, according to the Consumer Financial Protection Bureau. For some retailers, consumers must first contact the creditor, who then freezes the payment schedule and notifies the retailer of the return. For others, the customer contacts the merchant, who contacts the creditor.

All this to say that we are still only in the early days of “Buy now, pay later” programs, which have many variations and unknowns. As is always the case with any type of loan, people would benefit from reading the fine print.

So who is it good for?

Buy now and pay later can be advantageous in certain situations. Cabell proposed one in which an installment plan could be used to make a single emergency purchase, such as replacing a kitchen appliance, so the money doesn’t leave a bank account all at once.

Yet that’s not how most people use these loans, according to Cabell’s research. Most buy now, pay later purchases are for apparel and home furnishings, and 21% of young consumers say they use multiple buy now, pay later accounts.

“Suddenly you have eight payments hitting your card, and it can get messy,” he said.

Above all, the key to reaping the benefits of these interest-free loans is knowing that you can really afford what you’re buying, said personal finance adviser Jully-Alma Taveras. Equally important, she said, is to avoid using installments as an excuse to buy more things than necessary.

Elisa Salinas, 34, a teaching assistant in Chicago, believes she has kept control of the installment plans. She said she regularly uses the programs to fund purchases like shoes and glasses. Her payments are made on time because they arrive in her bank account when she receives her paycheck every two weeks.

“It’s more convenient than having a large amount taken out of your bank account all at once,” she said. But she admitted it was probably a bad thing that she didn’t know how the loans would affect her credit rating.