Credit scoring is broken — buy now pay later can help

Credit is an essential fact of life, yet millions of Americans lack access to affordable, responsible credit options. As consumer advocates correctly point out, our nation’s broken credit scoring system is in desperate need of an upgrade. That’s because traditional credit scoring can be spotty in whether and how it collects relevant data and can generate opaque and unfair outcomes.  

Credit scores are essential to more than getting a loan. They are increasingly important when renting an apartment, applying for home or auto insurance, or even getting a job. Yet, 45 million “credit invisible” Americans have thin credit files, and millions more are living with poor credit, locking them out of mainstream financial services and exposing them to predatory actors.   

Some argue that the path to building credit should only be through traditional financial products, including credit cards. But we believe a consumer’s real creditworthiness should include more than just one type of payment, and we argue for another path: buy now pay later, a product with zero to low fees for consumers, more transparency, and greater potential for building a solid credit record, but only if credit bureaus can modernize their systems.  

Imagine a young person trying to build a credit history for the first time. Credit cards often come with a high limit that makes it easy to overspend, compounding double-digit interest rates, and excessive late fees. The Consumer Financial Protection Bureau (CFPB) estimates that credit card companies made $14 billion in late fees alone in 2019 and just launched a new review of credit card penalty policies. Furthermore, Americans pay about $1,000 per year in interest on revolving credit card debt. This is not a formula for success for our youngest consumers.  

Today, thanks to innovation from financial technology companies, people have an alternative. The traditional pay-in-four buy now pay later (BNPL) model allows consumers to split a payment over four installments, often with little to no interest and low fees, over six to eight weeks. Unlike a credit card company, which can earn hefty sums even when a consumer misses a payment, BNPLs earn their money primarily from merchant fees. Consumers cannot continue using the service if they fail to make a payment. And, instead of starting a new customer with, for example, a $10,000 limit, BNPLs offer limited credit initially based on a single transaction, usually less than $250, and then extend it after the customer repeatedly makes on-time payments.   

But, the current credit scoring system only records one of these payment options (the credit card) as a positive transaction — and that’s a problem. Credit bureaus would currently see short-term payments on a BNPL as a negative, because the consumer maximized their available credit, and lower a consumer’s credit rating rather than reflecting the positive nature of short-term successful repayment.  

That’s why the BNPLs I represent at the Financial Technology Association — Afterpay, Klarna, Sezzle, and Zip — are in active conversations with the credit reporting agencies to modernize their scoring models to account for BNPL payments properly. The CFPB agrees that BNPL data could provide a fuller picture of consumer creditworthiness. The Bureau recently urged BNPLs and credit bureaus to collaborate on a uniform reporting scheme and asked the bureaus to build models that account for BNPL’s unique characteristics.  

Of course, limiting innovation because legacy credit score providers like FICO and Vantage are unable or unwilling to process this BNPL data in a consumer-friendly way is hardly what’s best for American consumers. Credit scoring algorithms should serve consumers, not the other way around.  

It’s increasingly clear that our credit reporting and scoring system needs upgrading. Legacy score-providers rely on limited data that might reinforce historical inequities while failing to consider data points — like rent and utilities — that would benefit underserved communities. These limitations mean that credit scores are not fit-for-purpose for a growing and increasingly diverse population. For example, six out of ten Black Americans have a low or missing FICO score compared to just over three in ten white Americans.  

Reform is needed, but relying on revolving debt products — with their extensive fees, high-interest rates, and debt traps — is not the answer. When used responsibly, alternative payment options like buy now pay later are a powerful tool to help people manage their finances and build a solid credit history. We should encourage innovation and update archaic credit scoring models to empower more people with fair and responsible access to credit.  

Penny Lee is the chief executive officer of the Financial Technology Association, a trade association representing industry leaders who are shaping the future of finance.