Does buy now pay later affect credit score?

For Canadians, "buy now pay later" (BPNL) services are a convenient financing option for online shopping. But, while these point-of-sale loans can prevent you from using your credit card for larger online purchases, there's still a possibility that it could negatively affect your credit score. To make more informed decisions about your money, stick around as we go over all there is to know about BNPL loans and how you can prevent your credit score from taking a dip.

What is buy now pay later (BNPL)?

Buy Now Pay Later is a type of short-term instalment loan that allows you to make and pay large purchases over time in a convenient way. Over the last couple of years, BNPL services have become more prominent, with major retailers welcoming BNPL loans as an option to their consumers.

How do BNPL loans work?

So, how do these instant money loans work? When making a purchase online, the option to "buy now pay later" will likely pop up as you proceed to your payment methods. Here, you'll find the option to use your credit card, debit card, or a partnered BNPL provider, such as AfterPay.

Once you've selected the BNPL provider, the repayment schedule for your short-term loan will appear. For example, if the total cost of your purchase is $60 after taxes, your schedule may look like $15 due today, another $15 due in 2 weeks, and so on, until the total amount is paid off. If you agree to this pay-later arrangement, you'll be redirected to the BNPL provider's website, where you'll likely need to fill out an application that will ask for your personal information.

Now, once you've submitted your application form, your BNPL lender will likely perform a soft credit check, which essentially looks at your credit score to make sure you're in good credit standing. Then, after you're approved, your purchase will be split into smaller, more manageable payments that will either be due every two weeks or every month on your credit or debit card with no added interest charges.

Does BNPL charge interest?

No, for smaller purchases, you won't be charged any interest on your payments. However, for larger purchases and longer repayment schedules, there is a chance interest could be applied. We recommend reading the terms and conditions of your BNPL loan beforehand to ensure you understand your financial obligations when shopping.

How is a credit score calculated?

Before we dive into whether buy now pay later (BNPL) loans can impact your credit score, let's take a second to go over what a score is, how it's calculated, and what credit bureaus are in Canada.

Credit Bureaus

Credit bureaus are private reporting agencies that collect your credit information and share information on how you use your credit with lenders you apply to borrow from. In Canada, the two main credit bureaus are Equifax and TransUnion.

Credit Report

The credit information collected by these two bureaus is then used to generate what is known as a credit report. Your credit report is a detailed summary of your credit history, which outlines what type of credit you've applied for, your credit score, credit utilization ratio, payment history, the amount of debt you owe, how many credit inquiries you've had, and more.

Credit History

Essentially, your credit history outlines your ability to repay lenders money that you've borrowed. Within this history, you'll find your recent credit activity, how long your credit accounts have been active, and, most importantly, your payment information.

Credit Score

Your credit score is a three-digit number that indicates to lenders how risky you are to lend money to. The higher your score, the more creditworthy you are, meaning you know how to use your credit responsibly. While several factors play a role in how your credit score is calculated, the information used from your credit report includes, but is not limited to:

• Whether you make on-time payments each month.

• The type of credit you have.

• If you carry a balance on your credit card.

• Your debt-to-income ratio.

• Records of insolvency or bankruptcy.

• How much outstanding debt you have.

• And more.

In other words, your credit score increases when you use your credit responsibly and decreases when you overspend and have trouble paying back the money you owe.

Unsure what your current credit score is? Get a free credit score check and build your credit with KOHO by applying for a virtual credit card with overdraft protection coverage to ensure you never miss a payment!

Will using buy now pay later impact my credit score?

So, can BNPL services affect your credit score and be listed on your credit file? While most BNPL providers run soft credit checks when you apply to use buy now pay later services, which won't impact your credit score. However, if you miss payments, not only will you be charged late fees, but your late payments will likely be sent to the credit bureaus.

Ultimately, this negative information about your late payments is what will lower your score, which will make it more difficult for you to use buy now pay later BNPL services in the future and take out larger loans in the future.

What are the advantages of using BNPL services?

For those who have their plans for spending and saving under control, BNPL loans can offer some pretty great benefits, including the following:

It makes purchases more affordable

One of the major advantages of using "buy now, pay later" for online shopping is that it can help you afford more expensive purchases by portioning your total into smaller purchases that are more manageable for you. For example, if you're tight on cash and your laptop broke, you could buy a new one without having to use your credit card or put the full amount down at the time of your purchase by using a pay later service.

Interest-free payments

Unlike credit cards that charge interest, BNPL loans are interest-free. So, if you're close to your credit limit on your credit card or want to avoid high interest, a BNPL arrangement may be the solution you're looking for.

May increase your credit score

As we said, BNPL companies may report payment information to bureaus. So, by making your BNPL payments on time, you could potentially increase your score.

What are the potential drawbacks of using BNPL services?

Of course, while pay-later PNPL loans do have many advantages, there are some potential drawbacks that we need to discuss so you can make informed decisions about how you shop and use your money. Let's take a closer look:

Bad spending habits? Watch out

While pay-later BNPL loans are convenient for some Canadians, those who like to impulse buy may want to stay clear. BNPL services make it easy to avoid the guilt of charging the full amount on your debit or credit card by giving you the option to make smaller purchases over time.

But remember, the cost of the item doesn't change. You'll still need to make payments toward that total cost. So, while a $500 sweater from your favourite store may only cost you $100 today, keep in mind that the $500 will be withdrawn from your account in a couple of weeks. Ask yourself: Is this purchase really worth it after all?

Associated fees

As BNPL services are a type of loan, there will be terms and conditions associated with your agreement. This means that you could be charged interest, and you will incur late fees for your late payments. Over time, these late fees can add significant debt to what you already owe.

Further, depending on your loan provider, there may also be associated fees should you decide to return the item to the retailer, making your original costs even more expensive.

Could lower credit score

As you know, when you miss payments, this information will be sent to bureaus, which could hurt your score. Additionally, if you default on BNPL plans, the company could send your non-BNPL payments to a collections agency. Once there, this information can stain your credit report and remain on your credit history, making it more difficult for you to qualify for traditional loans like mortgages in the future.

May lead to more debt

BNPL plans can encourage overspending, which can put you into more debt if you do not use your money responsibly, creating a snowball effect. Getting out of debt can be difficult and cause significant emotional distress. If you aren't confident in your ability to use these types of loans when making purchases, we recommend looking for other options.

Do you need a good credit score to be approved for buy now pay later services?

Generally speaking, yes, you will need a good score to be approved for BNPL plans, given that they are a type of loan, especially if the purchase is more expensive and you need a longer loan repayment term. When you send in your application, the BNPL provider will run a soft credit check on your credit report to see whether you're eligible for their services.

However, depending on which third party you apply with, a hard inquiry could be performed. In this scenario, your score will drop, and it may be more difficult to qualify for buy now pay later services.

What buy now pay later lenders are in Canada?

In Canada, there are currently several buy-now-pay-later lenders available. Some of the more commonly known ones you may come across at your favourite retailers include:

• KOHO

• AfterPay

• Klarna

• Affirm

• PayBright

• Sezzle

Each provider has their own approval guidelines and terms and conditions, so make sure to do a bit of research into each company before considering their services.

What to consider before moving ahead with buy now pay later options

If you've decided that you want to use buy now pay later as an option for your upcoming purchases, there are a couple of things you should keep in mind before applying to any one of the providers we've mentioned above:

• What type of credit check does the company require? If so, is it a hard inquiry or a soft check?

• Will the company report information about your payments to bureaus?

• What are the late fees you may incur if you aren't able to make your payments on time?

Remember, once you've been approved, you'll need to stay on top of your payments to avoid late fees and a potential hit to your credit file. If there's an option to set up automatic payments, we highly recommend doing so, as it'll save you the hassle of making manual payments each billing period. If automatic payments aren't available, program a calendar reminder in your phone so you don't forget!

Build credit with KOHO

While BNPL loans offer convenience to shoppers without responsible spending habits, your interest-free payments can incur late fees and put you into a cycle of debt while impacting your credit score. So, proceed with caution and seek other alternatives available, like a virtual credit card for online shopping from KOHO!

KOHO is a company that helps Canadians streamline their finances. From credit-building options, high-interest spending accounts, and options to get a cash advance with zero interest, whatever your financial goals or needs are, know that KOHO has a solution available for you.