Buy now pay later: How does it work?

By Rahil Sheikh
BBC Panorama

Published
Image source, Getty Images

More people are opting to use buy now pay later (BNPL) services for their shopping than last year, according to new data revealed to Panorama.

An estimated 15 million adults of all ages in the UK are actively using this form of credit, an increase of more than two million since the start of the year.

Among them are about 30% of all 20 to 30-year-olds, research by data company Equifax suggests.

However, there are concerns some people are spending more than they can afford.

What is buy now pay later?

It's a form of short-term financing, which has become increasingly popular.

Rather than paying the full amount of your purchases, BNPL allows you to spread the cost into smaller amounts over a short period of time, usually weeks or months.

The major players in the industry are Klarna, Clearpay and Laybuy. They have been joined by PayPal, which recently launched its own pay later model, while Monzo is one of the first UK banks to enter the market.

For most people, buy now pay later can be a convenient way of spreading the cost of their shopping.

But as the industry grows larger, the voices of concern are getting louder.

There are fears shoppers are spending more than they can afford and adding to existing debts, which they might already be struggling to manage.

How does buy now pay later work?

Choosing buy now pay later at the checkout of a participating retailer means the bill will be paid for in full by the BNPL provider.

That leaves the customer required to repay them, usually in instalments over a short-term fixed-payment schedule, and interest-free.

Most providers will charge a fee for any missed payments, and these can accumulate if more are unpaid.

Terms and conditions vary between companies.

Watch Panorama

Buy Now, Pay Later: The New Debt Crisis? Is on BBC One at 19:35 on Monday, and on iPlayer afterwards

How does buy now pay later make money?

The companies make money from the retailer, not the customer.

Most buy now pay later services take a cut from anything they help the retailer to sell.

Providers such as Klarna, Clearpay and Laybuy explain to retailers that by offering their services, they can increase average basket value and boost sales.

The more customers spend, the bigger the profits for the BNPL company.

More than half of major online stores in the UK offer BNPL payment options.

Does it affect your credit score?

When someone applies for buy now pay later credit, most services usually carry out soft credit checks, which they say help assess whether they can afford the purchase. These checks will not affect the person's credit rating.

However, BNPL services can refer missed payments to credit agencies. So, if payments are made late or missed altogether, a person's credit score can be affected.

If payments continue to be missed, some companies may pass unpaid debts on to a debt collection agency, which damages people's credit rating.

What are the problems with it?

In September 2020, the Financial Conduct Authority (FCA) commissioned a review, led by Christopher Woolard, which recommended the industry should be regulated to ensure better protections for its users.

The rapid growth of buy now pay later in recent years has raised some concerns, particularly around people spending more than they can afford.

Research by Equifax estimates buy now pay later users spend 51% more on clothes each month than online shoppers who pay up front.

Because the buy now pay later sector is currently unregulated in the UK, the services aren't under any obligation to run full affordability assessment checks on customers.

That means users can accumulate debt across multiple lenders, and the buy now pay later companies would be unaware of any other arrears they have.

What's being done about it?

Since the FCA review was published, the government says it has been considering how to regulate interest-free buy now pay later services. It says regulation should be "balanced and proportionate, ensuring customers are given appropriate protections".

The consultation will close on 6 January 2022.

It is unclear when regulation will actually begin and that is concerning debt charities and campaigners, who want to see it introduced as soon as possible.

What do the companies say?

Panorama spoke to three of the popular buy now pay later services and raised some of the concerns around affordability checks and debt.

Klarna said its "interest and fee-free short-term credit products are helping keep people out of debt".

It added that the credit it offers is linked to "a specific purchase with clear repayment plans and affordability checks to steer people away from debt".

Clearpay said it has "low initial spending limits, which only increase after customers consistently pay on time".

It also said it pauses an account if a single payment is missed, "so customers cannot revolve in debt", and late fees are capped.

Laybuy's co-founder Gary Rohloff said: "We participated quite heavily in the Woolard review and we were supportive of the recommendations that have subsequently been made which revolve around credit and affordability checking and continuous credit reporting."

He added: "We are supportive of the premise that the regulation needs to be appropriate for the utility of the product."