Buy now, pay later: Are installment plans a budget win or finance fail?

Amidst the sweatpants-clad days of lockdown, it’s no surprise Canadians turned to online shopping for a boost of morale. If your pandemic shopping habits still have you clicking “add to cart” for sport, you’ve probably noticed that when you reach the checkout page, instead of finding just your total, there is a new option to pay. You can now pay in installments through a third party, from the likes of buy now, pay later (BNPL) companies including PayBright, Afterpay, Sezzle, Uplift and others. So, instead of purchasing that shiny new $400 watch in one swift hit to your credit card, you can pay it off in four scheduled payments of $50.

With record-high inflation in Canada, there’s never been a more tempting time to splurge without completely depleting your chequing account. In fact, almost 60% of consumers say inflation makes them more likely to use BNPL services, according to a U.S. survey by Credit Karma.  

What is buy now, pay later?

While installment payment options have seemingly popped up overnight, you may be surprised to learn that buy now, pay later services (BNPL) have been available for a while.  PayBright, a Toronto-based service that launched in Canada in 2017 and has partnered with over 7,000 merchants, from Wayfair and Endy to Sephora and Hudson’s Bay, was recently bought out by Affirm, an American BNPL, for a cool $340 million. The U.S. company Sezzle also launched on this side of the border in mid-2019 and has over 1,000 retail partners, including brands with online shops, like Matt & Nat, Knix and Frank and Oak. Afterpay, the one with the most self-explanatory name, launched in Canada in August 2020, after success in Australia, New Zealand, the U.S. and the United Kingdom. Even major airline Air Canada recently bought in, partnering with Uplift to allow customers to spread the cost of their air travel over several fixed monthly payments (making that trip to Hawaii seem a lot more affordable). As retailers continue to partner with BNPL programs—like Apple’s partnership with PayBright—other financial companies, like banks, are entering the game. Take for instance CIBC, which launched the Pace It feature on its credit cards in 2019. Pace It allows cardholders to stagger payments on purchases of more than $100 across periods of 6, 12 or 24 months at lower interest rates than the bank normally charges on unpaid balances on the rest of their card. (Using Pace It costs 5.99%, 6.99% and 7.99% for each period, respectively.) Cardholders who qualify for the program simply use their banking app to select the purchase they’d like to pay for later in their banking app, and their available credit balance is unaffected. Scotiabank is getting in on the action too, with their SelectPay program, which works similarly to Pace It, but charges a monthly fee in lieu of interest. MBNA, American Express and Triangle credit cards all offer similar features on their cards now, too. Major credit card companies are buying into the payment trend, too. Payment heavyweight Mastercard has introduced a buy now pay later program, allowing users to pay for purchases in interest-free installments on their debit, credit and prepaid cards. Visa launched a similar program, Visa Installments, too. The concept may not seem that different from the layaway programs of yore, offered in department stores or payment plans offered on big-ticket items like auto and furniture. (Layaway was a retail finance tool brought in during the Great Depression, but it swiftly stopped in the ’80s  and ’90s when credit cards became more mass.) The main difference between layaway and BNPL? You can use BNPL services on purchases under $100, can you use them online and they’re becoming increasingly ubiquitous. And it looks like the programs are here to stay: the trajectory of buy now pay later programs in Canada remains strong. In fact, a 2021 report anticipates that BNPL will grow over 63% annually in Canada, with its value increasing to US$ 5955.5 million in 2022. So, is it wise to buy that full-price designer watch now and pay for it later? Here’s what you need to know before you buy into the installment plan trend.

How buy now, pay later plans work 

Think of it as “layaway in reverse.” Rather than making payments over time and eventually gaining possession of the item, you get it now and continue making payments afterward. Generally, once you sign up with a third-party BNPL, you make your first payment, your item ships, and you make the rest of the payments as per the agreed-upon schedule.  Which service you can choose depends on where you’re shopping, since the BNPL partners with the merchant directly. But make sure to read the fine print, as each company’s terms differ slightly. Afterpay, for instance, has no interest and no late fees, but caps the amount you can spend at first, gradually upping your limit as you prove yourself reliable. Other services charge interest (usually at a low rate) and some charge fees for late payment. 

Seriously, how much interest is charged on buy now, pay later? 

According to the Better Business Bureau, the third-party BNPL company makes money by charging retailers a small percentage of each sale made through their service and, in some cases, collecting late fees and interest from customers directly. Interest rates on these types of services range between 0% and 30%, depending on the retailer and your credit history. The payment period can last as little as a couple of weeks or as long as 39 months.  How does those annual percentage rates (APR) compare to the card in your wallet? Credit card interest rates range from around 8% (for low-rate cards) to 20% (for standard ones). Also, if you pay your credit card balance on time, you are not charged interest. (Did you know you might be able to negotiate for a lower rate on your credit card? We have more credit card tips here.)

Who’s using BNPL plans?

Gen Z and Millennials, mostly. According to a recent study done by the Financial Consumer Agency of Canada, people aged 18 to 34 were more likely to use BNPL services online than any other age group, at 71%. According to that same study, 42% said they used a BNPL to help them budget, 39% said they couldn’t afford the entire purchase right away and 23% said they wanted to avoid interest and fees. 

What happens if you miss a payment?

Between interest rates, the cost of borrowing and potential late fees, what’s the real cost? The short answer is—surprise!—it varies, depending on the service provider. 

Afterpay never charges interest under any circumstances and it will immediately freeze your account if you miss payments to prevent you from making further purchases. “If a customer goes late, we send them several reminders and try to work with them to collect repayment,” says Melissa Davis, Afterpay’s head of North America. “Afterpay never reports non-payments to credit bureaus. It should be noted that 95% of our customer payments are made on time.”  PayBright, on the other hand, charges interest rates between 0% and 29.95% APR, depending on the retailer, and some of their plans include a processing fee with each payment. And while Sezzle charges no interest, they do charge a fee for a missed payment, failed payment or if you’ve rescheduled your payments for the second or third time. Of course, there’s always the issue of potential fees and penalties through your financial institution if your payment fails, like pesky NSF fees if there isn’t enough money in your account to cover your outlay. And while BNPL services are relatively new to Canada, these payment options have been shown to drive Gen Z into debt across the border. One survey south of the border indicated that 43% of Gen Z BNPL users have missed a payment at least once. Considering the interest rates above, that can come with a hefty price tag.

How will using a BNPL service affect our credit scores? 

Afterpay does not run soft or hard credit checks or report to any credit bureaus (even on non-payments), so it won’t affect your credit score in any way. In PayBright’s case, it depends. They may do an instant credit check, depending on the amount of payment plan. Sezzle doesn’t report to credit bureaus, unless you sign up for an upgraded account called Sezzle Up, which includes a feature to help you build credit. (Don’t make this mistake with your credit score, though.)

What’s in it for retailers? 

Some business owners are eager to offer the service to make their products more accessible to customers. According to Richard Vanderlubbe, president of tripcentral.ca, the travel booking site started offering the travel-specific BNPL service Uplift to customers in 2019. He says integrating the service into his business has absolutely been worth it, and it’s a better option for his customers than buying on credit. (That said, for those who don’t carry a balance, credit cards have been shown as a worthy way to book travel, with perks such as redeemable travel rewards, car rental discounts and valuable travel insurance. See our picks for best travel cards.) “Many customers buy travel on a credit card that is already carrying a balance, and the interest rate offered by Uplift is quite a bit lower than credit card interest,” says Vanderlubbe. That’s about half, with the difference between 8.99% for Uplift and about 20% for the typical credit card. In fact, he’s found that the service stood out because of the lack of financial “traps” for his customers. “With many finance plans offering ‘free financing’ or ‘no interest,’ there are gotchas if a balance is not paid by a certain date—then very high-interest rates,” says Vanderlubbe. “With Uplift, they can pay the balance off whenever they want without penalty.” However, other business owners have reservations. Jess Sternberg, owner of the ethical clothing brand Free Label, considered using a BNPL service on her website after customers inquired about it.  “I sympathized with some customers struggling with the higher price tag of ethical fashion,” says Sternberg. “I didn’t want to exclude anyone from the ethical fashion movement.” But upon further research, she decided the BNPL philosophy didn’t align with her company’s values. “I realized it is way more sustainable and ethical to focus on financial literacy, such as education on budgeting and saving and the true cost of a garment, rather than encourage lower-income customers to take on debt for instant gratification.”  She’s also wary of her customers carrying a higher debt load in the name of fashion. “Debt only truly serves people who don’t need it. Those are the people that can leverage debt to their advantage.” As for some customers feeling excluded, she adds: “My customers know that if they can’t afford my clothing right now, then it’s OK to not shop. We actually need much less than we think.”

What does a financial planner think about buy now, pay later?

Should you consider using a BNPL? Shannon Lee Simmons, a certified financial planner and the founder of the New School of Finance, thinks BNPLs could come in handy if you’re trying to spread a larger purchase over a few paycheques. “The worry is that one needs to keep track of all the money they have coming out of the next paycheque,” says Simmons. “It’s a lot of mental math each month.”  Her first choice for payment? Good old-fashioned debit.  “You’re at no risk of overspending and you always know what’s in your bank account until the next payday.” If you’re looking at a bigger-ticket purchase that you’re not comfortable tapping your chequing account for, she suggests creating a slush fund—meaning, a savings account that is held in cash and readily available. “It’s not real savings. It’s just spending money you’re putting aside today to spend later on something that’s a bit bigger than what you can handle on one paycheque,” says Simmons. “If something has to be paid off over more than three months, I think that’s a red flag.” If you do decide to go the BNPL route, Simmons has some tips. “Like all financial tools, understand the benefits and understand the cons, and make a decision for yourself depending on your habits,” says Simmons. “Ask yourself: How long will I have to pay it back? Can I handle missing that much money for that long? What other purchases am I paying back? Will I need to use credit to pay for other fixed expenses?” She advises being mindful that if you use a BNPL service, you’ll have less money come your next paycheque and cautions against using too many services or not keeping track of payments. “If you’re worried about credit card [debt] and don’t mind the mental math of BNPL, they could work for you.” However, she urges consumers to keep track of online spending in general, no matter the payment method. “It’s too easy to spend mindlessly,” says Simmons. She recommends taking your payment credentials out of your devices and manually inputting it with each purchase. “Yes, this is annoying. But it slows down your ability to buy so that you give yourself a moment’s pause to ask ‘Do you actually want to do this?’” There’s good evidence to suggest BNPLs are targeting millennials, based on outright statements from providers, and the youthful brands these services are attaching themselves to. While some think it’s reimagining the classic credit model, millennials should proceed with caution: A new type of debt is still debt, and data proves they have enough of it already. According to the KPMG Millennials and Retirement poll, the debt-to-income ratio for young millennials stands at 216%, compared to 125% for Gen X and 80% for baby boomers at the same age. What’s more, 46% of millennials said that homeownership feels like a “pipe dream.” It’s in millennials’ best interest to reduce debt load, so if you can’t afford that Sephora haul or new gaming system outright, maybe it’s best to reconsider the purchase altogether. (Here are 10 strategies to get rid of credit card debt.)

Should you buy now, pay later?

The bottom line: Buy now pay later is a business designed to make you spend more. In fact, according to a report conducted for Visa, when installments are made available as a payment option, they’ve noticed an increase in the average ticket size of purchases and a rise in the average conversion rate for shoppers. Imagine how it feels to fork over a significant chunk of your paycheque to Visa or Mastercard to cover last month’s lattes; this concept is much the same. Before you click “buy” and the “buy now, pay later” option ask yourself: Do I want to be paying this off in three weeks’ time?