Buy now, pay later is not a cure for credit building

Buy now, pay later (BNPL) products have exploded in popularity in recent years. Nearly 8.5 million consumers used BNPL in one month alone (December 2021) and the industry is expected to increase 10 to 15 times its current size by 2025. 

Buy now, pay later products allow consumers to buy retail items with short-term loans, usually repaid by a down payment and three more installments over a six-week period. Consumers, especially younger ones, have flocked to BNPL as a supposedly better alternative to credit cards. But is it really a better mousetrap? With regards to helping consumers build a credit history, the answer is no — at least right now. 

Buy now, pay later products are far inferior to credit cards in establishing a solid credit record. Younger consumers who are avoiding credit cards might think they are building a good credit score with BNPL repayments, but they probably are shortchanging themselves. 

First, many buy now, pay later lenders aren’t even reporting payment information to the Big Three credit bureaus (Equifax, Experian, and TransUnion). The loans from these lenders are only reported when accounts become delinquent and are sent to debt collectors, which then report the negative information. So missing payments on a BNPL loan could definitely hurt a borrower.

Even when buy now, pay later lenders do report all of their information, including on-time payments, to the credit bureaus, not all of them include the information in the main credit reporting files. That’s the only place where it could have an impact on a credit score. Experian is creating a special database for BNPL data, which doesn’t impact credit scores — although that might actually be a good thing for right now.

That’s because, under current credit scoring models, including BNPL data in credit reports, even positive information, will only help consumers if the data is furnished in one specific manner — as an ongoing, revolving line of credit, similar to how a credit card account is reported. Unless BNPL accounts are reported this way, BNPL might end up hurting more than helping, even if the borrower makes all their payments on time, because of how the credit scoring algorithms work. 

According to FICO, the most popular scoring provider, its credit scores are composed of the following factors: 

• Payment History (35 percent)
• Amounts owed, including in comparison with credit limits/original balances (30 percent)
• Length of Credit History (15 percent)
• New Credit (10 percent)
• Types of Credit in Use (10 percent)
• VantageScore, which is the other credit scoring provider, uses similar categories.

If buy now, pay later credit is reported as a series of individual six-week loans that are opened and closed in a short period — which is how most BNPL lenders characterize their products — many of these factors will end up hurting a credit score. (BNPL credit actually should be viewed as a form of credit card, as we have urged the Consumer Financial Protection Bureau. The loans would show up as relatively new accounts with very short lifespans. This would lower the consumer’s score based on the “new credit” and “length of history” factors. In addition to these age factors, the impact of having a bunch of short-term, low-balance loans on the “amounts owed” factor is uncertain. 

However, if BNPL lenders reported all their loans to one consumer as a single revolving, open-end account, the product could potentially help a consumer’s credit score based on these same factors. In fact, there is some evidence of this already. In December 2021, Equifax issued a press release touting a study finding that “the majority of consumers in the study were helped by having an on-time BNPL tradeline in their credit file, with an average FICO Score increase of 13 points.” The important point is that the BNPL lender in this study reported its accounts as revolving credit, i.e., as a credit card. 

There are many problems with credit cards, and they can lead consumers too easily into unmanageable debt. But the reality is that the credit reporting system, and the algorithms that generate the all-important three-digit credit score, rely heavily on credit card data. Until we can be assured that the reporting of BNPL will truly benefit consumers by being treated similarly to credit cards, young folks on their credit journeys might need to start their records the old-fashioned way — with an actual credit card.

Chi Chi Wu is a staff attorney at the National Consumer Law Center