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The dangers of Buy Now Pay Later – what to look out for

With the Buy Now Pay Later industry continuing to thrive, we take a closer look at what risks to look out for.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

The Buy Now Pay Later (BNPL) industry has exploded in the last couple of years. The idea is it offers shoppers the chance to spread the cost of purchases, without having to pay interest. Retailers have been quick to jump at the opportunities on offer, with promises of 30% sales increases from providers.

Despite it being 18 months since a review from the Financial Conduct Authority called for ‘urgent’ regulation of the BNPL industry, the multi-billion-pound, unregulated market keeps rumbling on. And while the government lays plans for two more consultations, and the FCA hopes to start regulation some time in 2023, in the meantime, BNPL continues to spread.

It’s not just young people who are drawn to the attractions of interest-free borrowing, because a quarter of users are over the age of 36. And research in the US last year showed that a greater proportion of those earning over $50,000 used it compared with those earning less.

It means we all need to be on top of the risks posed by this kind of debt. If it’s beyond your means and you can’t afford to pay the purchase off, it’s probably not appropriate for your circumstances, even if interest free for a few months.

This article isn’t personal advice. If you’re not sure if something’s right for you, ask for financial advice.

What are the risks?

On the face of it, BNPL looks like a sensible way to borrow. There’s no interest to pay, so you can spread the cost of larger items over a few months, to help manage your budget more effectively without a cost. However, people still run into difficulties.

Part of the problem is that research shows we don’t think of BNPL as a form of borrowing – we consider it more of a budgeting solution. It means we’re less likely to take the time to weigh up whether we need to take on this debt.

It encourages people to spend more, on things they want rather than need. That’s because, by breaking the cost down into instalments, it means we focus on those, rather than the overall cost. If you recognise this in your own behaviour, it’s one to keep a close eye on.

At the same time, lenders often don’t carry out full credit checks when deciding whether or not to lend money. Instead, they opt for soft credit searches and evidence of previous payments. It means borrowers can run up a number of debts without anyone joining the dots.

While some providers, like Klarna, have started voluntarily reporting this borrowing to credit agencies, there’s no compulsion for other lenders to follow suit. This only raises the risk of over-borrowing.

How to build a rainy-day fund

Impact of the cost-of-living crisis

The cost-of-living crisis has already made a big difference to how we use these services.

Klarna’s results for the first three months of the year showed the amount being loaned out had barely shifted from the previous period. This is a major change of fortunes for an industry that mushroomed during the pandemic.

It shows just how hard we’re cutting back on the inessentials that BNPL is traditionally used for. However, there’s every chance that higher earners, who still have room in their budget for luxuries, will stand firm.

There’s also been a growing, and alarming, trend towards using BNPL for essentials. One in ten (11%) have used BNPL to buy essential clothes – like a winter coat. More than one in twenty people have used it to buy groceries (6%), and one in ten (9%) have used it for other essentials.

And it’s not only impacted those on lower incomes. The same research showed that higher-rate taxpayers were almost twice as likely to use it for essential clothes or other essentials as the overall figure. And almost three times as likely to use it for groceries.

There’s nothing fundamentally wrong with BNPL, used in the right way. It’s only when people borrow more than they’re meant to, struggle with repayments or use it to stretch themselves to the end of the month that the alarm bells should start to ring.

How to control your debt

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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