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BNPL (Buy Now, Pay Later) and How Does it Work?

Customers who wanted to buy something on credit from their favorite stores had two main choices for most of the last century. The first was to use a credit card to pay for it. The second way was to use a layaway program, which let them put an item on hold at the store, pay for it in installments, and get the item when all the payments were made. 79% of people in the US have at least one credit card in their wallet, but layaway plans are becoming a thing of the past. They are being replaced by buy now, pay later (BNPL) programs, which are run by third-party credit experts. Even though retailers can't charge interest to customers who use BNPL (in fact, BNPL vendors charge them a fee), they are making up for it with more sales. The credit market has also become fairer because of BNPL. It's getting more and more popular with people who don't usually use credit cards to buy things, for a variety of reasons.    

Buy Now, Pay Later (BNPL)

A buy now, pay later plan (BNPL) is a loan given to a customer at the point of sale so they can buy goods on credit but without a credit card. Shop Pay Installments from Shopify, Affirm, Afterpay, Sezzle, PayPal, and Klarna are all popular ways to pay. Many will do an instant soft credit check (one that doesn't affect your credit score) on the customer and then give them the money for a point-of-sale loan. Customers have different options for paying off the loan balance, which usually depends on the company used and the amount borrowed. Some payment options come with interest, while others don't, and some companies charge late fees or fees for missed payments. BNPL companies may charge the retailer a fee to make up for the fact that they don't charge interest to the customer.  

How does Buy Now, Pay Later work?

Here's how the BNPL process works for both consumers and retailers.
  • A customer shops as usual and starts the process of checking out. If you are a customer, you start the BNPL process the same way you would start any other online purchase. You go to your favorite online stores, pick out what you want to buy, and get ready to pay.
  • The BNPL vendor chosen by the store gives customers the chance to buy now and pay later. During checkout, the customer will be able to buy with BNPL, as well as with credit or debit cards or other payment methods.
  • A soft credit check is done on the customer by the lender. When a customer wants to use BNPL to buy something, they give the BNPL lender some personal information (such as a full address and Social Security number). The lender does a soft credit check on the customer right away to make sure that, based on their credit history, they will pay back the loan. This kind of credit check is not reported to the credit bureaus, so it won't hurt your credit score as a full credit check might.
  • The BNPL provider charges the retailer a fee. The BNPL vendor will take a cut of the sale, and the retailer will be billed directly for this. The fee, which is usually between 2% and 8% of the amount the BNPL lender sends to the merchant, is taken out of that amount. This is like how retailers and traditional credit card companies work together.
  • Over time, the customer pays off the rest of the bill. Most BNPL vendors don't charge interest if a customer pays off their full balance quickly (typically 30 days). If a customer needs more time to pay off their debt, lenders offer different payment plans with different interest rates. Like with a credit card, the customer pays less total interest the faster they pay off the bill.
 

4 Benefits of BNPL for Customers

When you use a BNPL service as a customer, you might get a number of benefits.
  • It makes things fair for people who don't have credit cards. About 20% of customers don't have a credit card, and 55% of those who do have one have already reached the limit on at least one card. A BNPL service has a lot of the same benefits as a credit card, but it can only be used for smaller purchases. You can even use a BNPL service like a credit card if you ask ahead of time for a virtual card number. This number will cover the exact amount of money you need to buy what you want. All of this is done on the BNPL vendor's website or through its mobile app.
  • Flexible payment options. At the point of sale, customers can choose between most BNPL services. As a customer, you can use BNPL to pay for the whole purchase, or you can use BNPL and another payment method to pay for part of your purchase (like a debit card).
  • Choices for payments with no interest. If you borrow money for a short amount of time and pay it back on time, you can avoid paying interest.
  • Soft credit checks don't hurt your credit score. Most BNPL vendors do soft credit checks on their customers to make sure they can get a loan. This won't hurt your credit score as a hard credit check would. On the other hand, if you pay your BNPL vendor late, this does get reported to credit bureaus, just like when you're late on credit card payments.
 

6 popular BNPL services

Buy now, pay later services are liked by retailers because they have been shown to increase sales overall. Because of this, there are now more BNPL services that can work than ever before. Here are six options that are well-liked.

1. Shop Pay Installments

Shop Pay Installments is a strong BNPL service that Shopify offers. It does this with the help of Affirm's network of lending partners. When merchants choose Shopify as their eCommerce provider, they can use Shop Pay Installments to let their customers pay their balance in four interest-free installments. The merchant still gets the full balance at the time of purchase, though. Shop Pay Installments gives online small businesses the same BNPL benefits as big retailers, like a higher average order value and fewer people leaving their shopping carts.

2. Affirm

Affirm is one of the biggest BNPL companies, and big stores like Amazon and Target offer it as a prominent way to pay. Affirm doesn't charge interest or fees for short-term loans (four payments with two weeks between each payment). For loans with longer terms, you have to pay interest, which can be anywhere from 10% to 30% APR depending on your credit, but there are still no fees. Even if a store doesn't already work with Affirm, you might still be able to use the service through a virtual card.

3. Afterpay

Block, which is based in the US, now owns the Australian company Afterpay (formerly Square). It is bigger than Affirm because it works with more than 100,000 stores. One of the most important features of Afterpay is a smart credit limit tool that lets shoppers set a spending limit based on their own credit history. This should keep them from spending more money than they can afford to pay back. It also reminds you to pay on a regular basis, and its virtual card service is easy to use. Afterpay, unlike Affirm, does charge late fees, but you'll never have to pay them if you pay on time. Its interest rates are between 10% and 30%, just like Affirm's.

4. Sezzle

Sezzle is a BNPL company that lets customers push back payment due dates by up to two weeks with a signature feature. Sezzle does require a 25% down payment on all purchases, but you can pay off most loans without having to pay interest. Sezzle actively seeks out younger users and says it is "on a mission to help the next generation become financially independent." It is sold in more than 44,000 stores, but the biggest stores don't like it as much (one notable exception is Target, which does offer Sezzle as a payment option).

5. PayPal

PayPal is probably best known as a safe way to pay online or as an app that lets people send money to each other, but it is also a BNPL lender. It's a most popular way to lend money is through a service called "Pay in 4," which splits transactions into four scheduled payments with no interest. This service can only be used for purchases between $30 and $1,500. Affirm, on the other hand, will lend up to $17,500. The benefit of using PayPal is that it has almost 30 million active merchant accounts. This means that it is easy to use and doesn't require extra steps like getting a virtual card number. The standard interest rate for PayPal is about 24% APR.

6. Klarna

In 2005, Klarna began in Sweden. It has over 85 million customers and works with hundreds of thousands of merchants around the world. Klarna may do a soft credit check or a hard credit check on you, depending on the type of loan you want to take out. Klarna doesn't have strict limits on how much you can borrow. Instead, it uses a metric it calls Purchase Power. Its official website says that Purchase Power is "an estimated amount based on things like how you've paid Klarna in the past and how much you still owe." If you have good credit and a history of making payments on time, Klarna may be able to give you larger loans at the point of sale than most other BNPL vendors. When you do have to pay interest, the most you will pay is 25%.  

Conclusion

As a retailer who is thinking about a BNPL option, you will have to weigh two things. One is the fees that BNPL vendors charge for each purchase. The other is that people who use a BNPL service have more items in their shopping carts. Most BNPL stores don't tell the public what their merchant fees are, but they are usually between 2% and 8% of what a customer buys. This makes them like the big credit card companies. So, it may not cost a merchant any more to accept BNPL services than it does to accept credit cards. And, like credit cards, a BNPL service can make customers want to buy more. Retailers like Macy's, Peloton, and Rue21 have said that customers who use a BNPL service have significantly increased sales. For these and many other vendors, the extra sales more than makeup for the fees they have to pay.
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