Thursday, September 21, 2023
Spending & Saving

The SCARY Truth of Buy Now Pay Later

As the old saying goes, if something sounds too good to be true, then it probably is, and in this blog, we have to talk exactly about how this applies to buying now-pay-later services and why I think you really should just try to avoid payment options like a firm, afterpay, and clarinet altogether. Now I think it makes sense why buying out pay later has become so popular lately because it really does sound like a good deal at first. Instead of buying something at full price upfront, you can just split that up into four easy payments over the course of six weeks and even pay no interest. That way, you get to enjoy your purchase now and pay it off in a way that maybe seems more manageable for your budget. 

But really, when something is being marketed as being this good to you, there’s usually a catch to it. And I think that as we dive a little bit deeper into these “buy now, pay later” services in this blog, you’ll start to see the truth about why they can actually be a big problem for a lot of people, especially right now in 2023, as everyone’s cost of living continues to rise with elevated inflation. So let’s get right into how buying now and paying later works so that hopefully you can actually avoid some of the hidden tricks that these companies are using to make money off of you. 

Now I’m going to start off by jumping over to a retail website like 

That way, we can quickly go through what the buy now, pay later process looks like when we’re buying something like a pair of sneakers. So here on Nike’s website, I’ll just go ahead and add this random pair of sneakers to my cart that has a price of $160. And then when we go over to my cart right here, we can see this option to use Klarna, which is one of those buying-out pay-later companies that I mentioned. Now it says interest-free payments, so that usually gets people’s attention. And then when they select this option, it says that for this $160 purchase, Klarna will allow us to split it up into four equal payments of just 40 bucks each.

We’d make our first payment of $40 today and then another $40 payment every two weeks after that. So then, at the end of six weeks, we would have paid a total of $160 with no interest. So that sounds pretty good. And it’s kind of hard to believe that these “buy now, pay later” companies are even making money if there’s no interest. But I’ll explain some of the smart ways that they figured out how to profit from this sort of model because it’s really interesting how it all works. Now, technically, you could use a credit card to buy something like this in a similar way, because there are time frames within a credit card billing cycle and the payment due date that can give you a few weeks to pay off your balance without any interest as well. 

But for some people, credit cards have become associated with getting into debt. And plus, it takes maybe seven to 10 days to open and then get a new credit card in the mail before you can even use it. So these “buy now, pay later” options seem easier because they’re what’s called “point of sale loans,” where you get approved for this mini installment loan on a case-by-case basis. And then you actually get to walk away with the item you want to buy today, which gives you that instant gratification. Now some people try to make the argument that using “buy now, pay later” services actually makes sense financially because if they buy at 0% interest, they can then go ahead and invest the extra cash that they don’t have to pay upfront.

That way they can supposedly profit from a spread between their investment return and the 0% interest on the cash they’re holding onto. But don’t buy into this idea, because are you really going to invest that extra $120 that you don’t have to pay today in that Nike sneaker example? And then every two weeks withdraw $40 from your investment to make that payment. And also remember that six weeks is such an incredibly short period of time to get any sort of a return. So the odds of your investment going up or down are probably close to 50-50 anyway. So it just isn’t realistic.

We have to talk about why “buy now, pay later” has become so popular lately and is now being offered by pretty much any retailer you can think of. So one reason the companies like Nike from that example have begun to offer “buy now, pay later” as an option is because there seems to be evidence that not only just splitting up this purchase price over time actually increases the average order size from their customers, but it’s also been found that these payment services help to increase conversions, meaning that the customers are actually more likely to go through with a purchase when “buy now, pay later” is available instead of just adding something to their cart and then abandoning their cart entirely without a purchase. 

So ultimately, that means that these increased sales for retailers are really coming from customers who are unknowingly spending more compared to what they would normally spend with more traditional payment options like cash, a debit card, or a credit card. Obviously, retailers want to see higher sales and better conversions, and right now they especially want to see the stuff because, once again, inflation is making all of these living costs and anything else more expensive than usual, which can lead to lower consumer demand and discretionary spending at places like Nike. So buying now and paying later can sort of act as another tool that companies can use to give a little push to their customers to just keep spending because payment plans can sometimes make it harder for people to understand what they can afford and what they can’t afford. 

We can even think about this with a similar but more extreme example: when someone is buying a car. So if you saw a car for $20,000 that you won, you probably either don’t want to pay that or can’t afford to pay that full $20,000 price upfront, but let’s say instead you could finance it at 5% for 36 months. That would give you a monthly payment of around $599, but maybe even that monthly cost is a little bit high for your budget. So to make it sound more affordable, the dealership might stretch out that purchase even more for you by saying that you could finance it for 72 months at that same 5% interest rate. Now your payment is only around $322 per month, so the car might feel more affordable to you even though you’re still buying the same $20,000 car. In fact, by stretching out that loan now, you’ll pay twice as much interest over those 72 months compared to a 36-month loan. 

Back to buying and paying later. Even though the majority of these six-week payment plans have a 0% APR, the psychological trick remains the same because all of these plans stretch out your payments to make something appear more affordable, and also many of these companies do offer additional longer-term financing options for maybe three to twelve months that actually have high APRs that are similar to credit cards, so I think the problem with buying out pay later services is that they can become elitist. Now another really important thing that we have to talk about here is related to the tendency that many people have to want instant gratification with things. This is one reason why buying now and paying later can be the perfect trap for people to spend money on items they might not actually need, and if we take a look at any of these websites of buy now, pay later companies, we can see that they all talk about the retailers they partner with. 

Almost all of them are selling mainly discretionary items that are more things we might want than things we always need to spend money on, so that could be TVs, electronics, new clothes, or even different types of travel. Now, I realize that not everyone out there is purely using buy now, pay later for luxuries they want to have, because I know there are a lot of people out there living paycheck to paycheck who use these services to pay for necessities like food, household items, or even school supplies for their children. So, in these situations where cash is tight and some people really need to pay for something they need without paying in full, I’d say that using buy now, pay later is an okay option, at least in the short term, but the only way to use it effectively is to not make it part of your long-term financing solution. 

All it takes is for several of these loans to add up or for you to lose track of just one, or maybe your income decreases for some reason, and then you could fall behind on a payment and get charged late fees or even start to damage your credit. Some of these buy-now-pay-later plans might only do a soft credit check when you apply, which won’t affect your credit score, and they won’t always report on-time payments, but late payments after a certain time could get reported and start to hurt your score. So just do your own research on what payment plan you might be looking to use and the implication of using that because none of this is financial advice it’s just my own opinion as someone that’s interested in this stuff. 

But I think the best plan when using buying out pay later for necessities is first of all to stick to a budget that way you’re not buying stuff you don’t actually need and you’re not accidentally overspending and then second of all you really should be actively working at the same time to put some money away in an emergency fund that way you can create that margin of safety and then you’ll be much less likely to have to turn to any type of consumer debt in the future just to make ends meet. 

Now there’s actually another strategy for taking advantage of buy now, pay later plans that I think is much healthier and that also allows you to pay for things with 0% interest; that method is called the “save now, pay later” method. Now, I’m definitely not the first person to come up with this because, basically, it’s like how we all saved money as we were growing up as kids by saving up things like birthday money and allowances, but if you can’t afford to pay for something in cash right now and it’s not an absolute necessity that you need to have today, just try to fight that urge for instant gratification and save up for a purchase instead. 

So with that Nike sneaker example, if you can say to yourself, “Okay, I can wait to get those sneakers in six weeks, and all I have to do is set aside $40 today, and then in another two weeks when another paycheck comes in, I’ll set aside another $40, and then another, and another, until I have that full 160 saved up, and only then can I go to Nike and buy those shoes,” you’ve basically done the exact same thing as buying out and paying later. The only big difference is that you get the shoes six weeks later because you had to wait and delay gratification, and that’s it. Again, using buy now, pay later for necessities is one thing, and I understand that by turning to alternative payment options to make ends meet, but these point-of-sale loans appear to be targeting Gen Z and younger generations, as well as their desire to buy things to impress others. 

With save now, pay later, you don’t have to worry about missing payments and those late fees, and you’re also not helping to fuel the new buy now, pay later trend, which could be bad for prices in the long run because of the main way that these companies actually make money, and I had to touch on that last year because it’s actually really interesting. As I said before, there seems to be evidence that buy-now, pay-later purchases can have higher order sizes and higher conversion rates on average, but we also have to consider what retailers like Nike are paying companies like Klarna to get these things. Now, when we pay for something with a credit card, it’s usually going to be more costly for retailers than if we used cash or a debit card, and that’s because in order to accept these credit cards as a method of payment, retailers have to pay Those credit card companies have what are called interchange fees, which can be maybe two to three percent of the purchase price, but it varies depending on the credit card that’s used. 

Compared to paying with cash or a debit card, there’s really not much of a transaction cost there—probably not zero, but it’s basically very little. Now that credit cards are really the dominant form of payment and retailers need to accept them for business, they need to do something about those extra two to three percent fees because their profit margins are already pretty thin. So what they do on average is usually increase the prices for the things that they sell to reflect those higher transaction costs, which means that the costs of those credit card interchange fees are basically passed on to the customers to some degree. Now the reason I’m mentioning this here is that buying out and paying later is sort of another payment option that’s growing in popularity, and there’s a similar cost for retailers to accept it. 

So buy now pay later companies essentially run like a salesperson that gets paid a commission because when customers see the logos for Klarna or afterpay at checkout they seem to be much more likely to make a purchase and their orders are larger on average and retailers pay companies like this for helping to generate the sale but instead of maybe two to three percent fees that retailers pay for accepting credit cards the average buy now pay later fees might be closer to four to six percent depending on different factors. 

So in that $160 sneaker example, the way it would look is that Nike would say thanks Klarna for getting this person to buy our sneakers and then essentially Nike would generate revenue of 160 from this purchase minus maybe a five percent commission of eight bucks that Klarna would get for helping to make this sale. So really Nike is only making $152 instead of the 160 they would have received if someone paid cash for the sneakers in one of their physical Nike stores and that means they would have a slightly smaller profit margin from the sale. 

Of course, they can afford that; however, if we amplify this type of spending behavior across tens of thousands of retailers and tens of millions of customers as “buy now, pay later” becomes more common, then it’s not unreasonable to think that eventually, companies like nuggy would just pass on more of these costs to their customers over time, or maybe they would make some other adjustments and not give employees proper raises or cut costs in the supply chain or some other areas. 

This is all just an oversimplified example to make a point but what I’m trying to say is that just because you see those words for four interest-free payments at checkout somewhere down the line someone has to be paying extra for buying up pay later companies to make any money and because they’re a consumer-facing business those extra costs are going to get passed on to consumers in one way or another. 

Now I’m curious: have you ever bought now and paid later before, or do you think you will? I know I haven’t personally used them, and I don’t plan to, but let me know your thoughts in the comment section below. Also, I just want to be clear that I’m not trying to bash buy now, pay later services completely here in this blog, but my whole message with any payment method is pretty simple and consistent: just spend your money intentionally and within a budget; don’t buy things you can’t afford; and try to live below your means. 

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