How buy now, pay later loans could alter credit
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 might pay more for insurance or make large security deposits to get utilities or rent an apartment.
Recently, the three major credit bureaus announced plans to incorporate “buy now, pay later” plans, a hugely popular type of point-of-sale financing that until now has mostly stayed outside the traditional credit ecosystem.
But no one should expect their buy now, paid later instantly, to open the door to better credit. If you want reliable access to the greatest number of lenders, building credit through traditional means is the best route.
BUY NOW, PAY LATER LOAN POPULARITY RISES
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 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 are using the payment and purchase data they collect from customers.
CREDIT OFFICES WORK ON 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 could likely manage credit among the millions of “invisibles” – people with no credit history – as well as those who have too little information in their file. files to generate credit scores. TransUnion’s Pagel called buy-it-now, pay-later data the biggest opportunity for financial inclusion in a generation.
How offices will go about this is a work in progress. 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 studies 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’re trying to build or rebuild your credit, you 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 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 column was provided to The Associated Press by personal finance website NerdWallet. Weston is a NerdWallet columnist, certified financial planner, and author of “Your Credit Score.” Email: [email protected] Twitter: @lizweston. NerdWallet writer Bev O’Shea contributed to this report.