Money News digests news stories about money to examine what’s really behind the headline. This week, we look at a news report on buy now pay later and what it could end up costing you.
Money Bite Sized – Minute Read:
Buy now pay later services are a line of credit.
Like a credit card, you purchase a product and pay for it later rather than paying upfront.
Using buy now pay later services can impact your credit score.
This can make it harder to access credit in the future, like a mortgage to buy a house.
Ultimately, if you know you can’t afford it, don’t buy it.
Have you heard of buy now pay later? Young people are the target for these services because we want instant gratification. We are targeted by these services on social media so it becomes harder to say no to using them. This is particularly true if you see your friends using them. So many people use buy now pay later services that it feels like they’ve been around forever.
But what actually is buy now pay later?
It’s a line of credit or debt. Your parents likely used something called layby. Layby meant that a store put a product aside for you. You made regular payments and when you paid the full amount, you got to take the product home. Buy now pay later is layby in reverse because you get the item first – then pay for it.
Many buy now pay later customers are younger consumers and students who describe themselves as part-time employed or unemployed.
This statistic was reported in an ASIC regulator report on buy now pay later in November 2018. It makes sense for young people to use a service that gives them exactly what they want. The risk is that if you’re working part-time hours or are unemployed, your income may fluctuate. This can make it difficult to pay back an item that you’ve committed to buying.
Since that report, buy now pay later services that have exploded. One service, afterpay declared annual sales of $1.1 billion and 9.9 million users. It’s competitor, Klarna is one of Europe’s highest-valued fintech companies, with a value of $10.6 billion.
What do we think about buy now pay later?
We don’t mind whether you use buy now pay later services or not. They’re a financial product that exists in the market and you need to be an adult to use them. We do want to discuss how to use them without it putting you in a difficult financial situation.
When this story, appeared on the Daily Mail website on 10 December 2020, we were interested to discuss it further.
Here’s the money news in more detail:
How the purchase of a $500 dress using Afterpay almost cost a young woman her dream house – as she issues a stern warning to buy-now-pay-later shoppers during the Christmas retail frenzy
The headline is intriguing. Many people use buy now pay later services without thinking about it. The headline suggests that this behaviour adds up over time in ways that many of us hadn’t considered. This includes past mistakes with buy now pay later services changing whether we can buy a home later in life.
A shopper’s experience:
A shopper says using buy-now-pay-later services nearly cost her dream home after the purchasing scheme ruined her credit rating. Leanne, 33, a regional sales leader from Melbourne, signed up to Zip Pay to buy a $500 dress from Camilla for her sister’s wedding in mid-2016. After finding the service handy, she later started using After Pay as well as an alternative payment option to help take the edge off bigger expenses.
This seems very relatable. She’s a millennial, the target market for both buy now pay later services. She’s also using it for a big purchase that she may not have the money for upfront. Her job also means that she has an income source to pay off what she buys. There’s a risk here in that sales jobs tend to work on commission. That could mean her income isn’t consistent each pay period, which makes budgeting for repayments more difficult.
What went wrong:
But when she went to apply for a home loan in July this year, her mortgage broker said using the seemingly harmless services had plummeted her credit rating. ‘My fiancé and I are pretty good savers, we have always been financially savvy when it comes to money. When I saw the dress I thought I’d sign up to Zip Pay to help space out the amount I needed to spend,’ Leanne told Daily Mail Australia.
‘I always repaid the amounts back in full and never was in arrears. ‘When he said my credit rating was on the low side, I was so confused because it had always been pretty good.’ Leanne’s fiancé’s credit rating had also taken a hit from using Afterpay, but the combination of having both buy now pay later services on her record was the perfect storm for having a red mark against her name.
When I read the comments on the original article, it concerned me that they were all attacking her. At Money Bites, we don’t blame or judge – we learn from others experiences.
A buy now pay later service is similar to a credit card. You’re purchasing a product but paying for it later in instalments rather than paying for its full price upfront. You are being given a line of credit and need to repay it over time. This also shows banks how you manage credit when they’re considering you for future credit products like mortgages.
Why the issue happened:
After changing mortgage brokers, they were able to secure a single bank willing to lend them the money to buy their first home. Each time a person applies for credit, a credit provider will make an enquiry into their file before it is granted, with each enquiry made tallied on their credit record. Credit enquiries can be considered ‘good debt’ or ‘bad debt’ depending on what type of loan is being sought. When Leanne set up the services, Afterpay and Zip Pay made enquiries into her file which were scored as ‘bad debt’, subsequently lowering her credit rating.
‘There were initially a lot of tears when I wasn’t approved after finding a home we loved. If I had known signing up with Zip Pay and Afterpay would have created this nightmare for me I would never have bothered,’ she said. ‘The mortgage broker said “if you are using buy-now-pay-later programs, you are saying you can’t afford something outright, which is telling the bank you have financial issues”. ‘It implies that you are putting yourself in debt on a regular basis, which means you cannot afford to have a loan.’
The article is essentially saying that buy now pay later services might check your credit file when you apply. This credit check might contribute to lowering your credit rating.
We’ve checked out the terms and conditions of both services.
- Afterpay states that in applying to use their service, you “authorise us to make, directly or through third parties, any enquiries we consider necessary to verify your identity and assess your capability to make payments” which could include “ordering a credit report, performing other repayment capability checks and verifying information”.
From what we read, both companies mention that credit checks are possible. This is why you need to actually read the terms and conditions when signing up to financial products. Not just tick the box like you might do for a phone update.
What the article’s nominated expert says:
This scenario is becoming all too familiar with credit expert Victoria Coster, founder of Credit Fix Solutions who fixes Australian’s credit reports for a living. ‘Unfortunately, Leanne isn’t the only one who is out there having an affected credit rating from simply just signing up to buy now pay later services’ Ms Coster told Daily Mail Australia. ‘2020 has seen a rise in the number of consumers applying for credit repair, who need to remove ‘buy now pay later’ enquiries.
‘Consumers are being knocked back by the major banks and mainstream Lenders due to having just one or two of these types of enquiries.’ With COVID-19 bringing about a tightening in lending restrictions, just one ‘buy now pay later’ enquiry can prevent a consumer from obtaining home loans, car loans, personal loans, or credit cards. ‘A home loan enquiry is not seen as risky as it is potentially a ‘good debt’, but the credit reporting bureaus deem ‘buy now pay later’ enquiries as a ‘bad debt’, and therefore high risk, indicating that the consumer has a pattern of bad money management, which negatively impacts their credit score’ Ms Coster said.
The education around good and bad debt is an interesting point. We tend to think of all debt as bad. Many financial advisors and educators like Dave Ramsey share the view that debt is bad. However, you’re likely to need a mortgage to buy a house so will have to engage with and manage debt.
So what’s the difference between good and bad debt?
A good debt improves your financial position and grows your wealth over time. This could be an education loan that will enable you to earn more money. It could also be a mortgage to buy a house, which is an asset that might grow in value.
A bad debt doesn’t improve your financial position and will eat into your wealth. This could be going into debt to buy products like clothing, which you probably need rather than want. These products often have little value long-term so won’t give you a return on your purchase.
What the buy now pay later companies say:
Zip Co Director of Corporate Affairs Matthew Abbott said he could not comment on specific cases but making credit enquiries was a vital company measure. ‘Zip is a responsible lender and that means we do credit checks on every single applicant,’ he said. ‘But we don’t control how an actual credit score is calculated. The credit bureaus use many data points and a proprietary algorithm to calculate these scores – and this is something on which Zip has no visibility.’ Zip Co failed to answer questions on what measures are currently in place to notify customers about the potential credit score implications at the time of signing up.
An Afterpay spokesperson said using the service cannot affect your credit score. ‘Afterpay is built differently: we start people on low limits that only increase after proven, positive repayment behaviour. We stop people spending as soon as they miss a payment,’ the spokesperson said. ‘Afterpay does not do credit checks, and we don’t report to credit bureaus – and never have.’ Buy Now, Pay Later programs allow shoppers to make purchases in-store and online and receive the product without paying the full price upfront, enabling items to be taken home while they are paid off in instalments. While the purchase cost is interest-free, there are other fees associated with using the services.
I do appreciate that the article contacted the buy now pay later firms mentioned and actually asked them about their process. The reality is that if you miss payments for buy now pay later services, you are failing to pay back a line of credit. That makes you a riskier choice if you approach banks for a mortgage to buy a house. A mortgage is a line of credit and your credit history can show how you’ve managed credit in the past.
Ultimately, if you can’t afford it, don’t buy it.
We know from this ABC news story that 1 in 5 consumers using buy now, pay later miss payments. The consequences for using the buy now pay later services can impact your credit score. If you miss payments and fail to pay back your credit line, you could be flagged as a riskier candidate to lend credit to. Keep this in mind when using buy now pay later services and consider saving up for what you want to build savings habits.