‘Buy Now, Pay Later’ Loans May Soon Play Bigger Role in Credit Scores

“Buy now, pay later” online loans are getting attention from both regulators and the credit industry as consumers increasingly turn to them, and they may soon play a bigger role in credit scores.

Loans from financial technology companies, including Affirm, Afterpay and Klarna, offer an updated version of layaway plans, once a common option for shoppers to pay for big-ticket items in installments. The new offerings, widely available online or via mobile apps, are generally used for smaller purchases, like shoes, apparel and concert tickets, and allow the buyer to get the items right away.

Shoppers typically apply at checkout and can get approved quickly, with a cursory credit check. They then pay for the purchase in four or fewer installments over several weeks. Borrowers usually don’t pay interest, as they would with traditional credit cards, but some lenders may charge fees for late payments.

Pay-later loans are attractive because they give people flexibility to pay over time but without any interest. They are most popular with millennials and Gen Z consumers — people now about age 40 or younger — according to a recent report from Fitch Ratings. They also appeal to people who may have lower credit scores or scant credit history, which makes qualifying for traditional loans and credit cards at affordable rates more difficult.

For now, many of these smaller, short-term loans aren’t reported in a consistent way to credit bureaus, so borrowers don’t build a formal credit history by using them.

But as the loans become more mainstream, that’s changing. The major credit bureaus are working to include more pay-later loans in consumer credit reports. Equifax, for instance, said two weeks ago that it had created formal standards for reporting the loans and expected to begin adding them to its consumer credit files in late February.

Experian said it already includes data on pay-later credit, including short-term loans, in its credit reports and is working to add more. TransUnion is “well on our way” to including such data, said Liz Pagel, senior vice president and consumer lending business leader at the credit reporting company.

All that means that shoppers’ track records of making pay-later installments may increasingly influence their credit scores — those three-digit numbers that summarize your credit report and determine whether you qualify for a traditional loan or credit card and what interest rate you will pay.

Equifax says that’s a good thing because lender reporting of on-time payments can help shoppers build credit histories. “We have been emphasizing the opportunity to report, in order for consumers to benefit,” said Mark Luber, chief product officer for United States information solutions at Equifax.

Equifax says a study of anonymous pay-later data found that a majority of shoppers were helped by having an account with on-time payments in their credit file, with an average FICO credit score increase of 13 points. People with scant credit histories, who may not qualify for traditional loans, had an average FICO score increase of 21 points when on-time pay-later payments were added to their files. (The average basic FICO score is 716; generally, scores of 670 or above are considered good).

That could help consumers who pay their loans on time by helping them to build a positive credit profile, said Lauren Saunders, associate director of the National Consumer Law Center. But, as with traditional loans and credit cards, paying late could tarnish their reports.

“The jury is still out on this,” Ms. Saunders said.

As it is, missing an installment payment or failing to pay at all can already harm a shopper’s credit. If a consumer fails to pay, some companies may cut off access to new loans orsend the account to a collection agency, and that could show up on credit reports.

The financial website CreditKarma said an online survey conducted on its behalf in August found that close to half of American adults had used some sort of pay-later service. About one-third of them reported missing one or more payments. Of those who missed at least one payment, nearly three-quarters said they thought their credit scores had fallen as a result.

Most people said they used the plans to pay for purchases of $500 or less, with about one-third financing purchases of $100 or less, the survey found.

Equifax said it would encourage pay-later companies to report consumer payment histories. Pay-later companies contacted said they generally supported the practice.

Reporting pay-later loans to credit bureaus helps protect consumers and “enables all responsible underwriters to more accurately assess risk and help prevent consumers from being overextended,” Affirm said in an email.

Francis Creighton, the president and chief executive of the Consumer Data Industry Association, a trade group for the credit reporting industry, said it was important to have pay-later loans reflected on credit reports so lenders could have a true picture of a loan applicant’s overall credit profile. But because the loans are structured differently from traditional loans, he said, the credit bureaus first had to resolve “technical” issues to add them. “We have to make sure we do it right,” he said.

At the same time, the federal Consumer Financial Protection Bureau has stepped up scrutiny of pay-later companies. In mid-December, the bureau opened an inquiry, asking five companies to supply details about their business practices by March 1. The bureau, citing the “explosive growth” of pay-later during the pandemic and through the holiday shopping season, said it wanted to understand the potential benefits and risks to consumers better. The agency said it was also concerned about how the companies use the data they collect from customers.

The agency noted that if consumers use the loans for multiple purchases, they may have trouble keeping track of payments. “Because of the ease of getting these loans,” the agency said, “consumers can end up spending more than anticipated.”

Installment payments are usually deducted automatically from debit cards, so shoppers may be charged overdraft fees if they don’t have enough money in their accounts to cover the payments. If shoppers pay the installments with a credit card, they may run up additional debt and interest charges on their card if they don’t pay their installment balance in full.

Also, the consumer agency said, pay-later loans carry fewer protections than traditional credit cards, like the right to dispute a charge if a product is faulty.

Members of Congress, as well as consumer groups, have called for more oversight of the companies, noting that because the installment loans don’t use traditional credit checks, it’s not clear whether borrowers have the ability to repay multiple loans.

Here are some questions and answers about buy now, pay later credit:

What should I consider before using pay-later loans?

Ms. Saunders said consumers should be confident that they will be able to make the required installments in the time allotted. With traditional credit cards, customers have a consistent payment schedule and a statement summarizing all charges, but someone with multiple pay-later loans may have to juggle multiple due dates. “They definitely want to make sure they’re keeping track of their payments,” she said.

A spokesman for FICO, Greg Jawski, said that regardless of the type of credit, the advice for building a strong credit score is the same: Keep “your debt levels low and pay your debt on time.”

How can I tell if a company reports installment loans to the credit bureaus?

Many companies do not yet report short-term pay-later loan payments to the bureaus. But companies usually disclose such details in their privacy policies or their terms and conditions statement, so that’s a good place to look. Companies also may include sample agreements on their websites.

Do credit cards offer free installment plans?

Some credit cards offer zero percent interest for specific periods of time, but you generally need stellar credit to get this.

Some traditional cards, including American Express, now offer flexible payment plans, in response to the pay-later start-ups. There may be fees to set up the payment plan, but youwon’t have to pass a new credit check if you already hold the card.