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'Buy now, pay later' loans can decrease your credit score even if you pay on time—here's what you need to know

Select explains how some point-of-sale loans can decrease your credit score even when you're making your payments on time and in full.

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When Ryan Stanton was moving into his new apartment after graduating from college, he opted to buy some household items he needed through 'buy now, pay later' providers Affirm, Klarna and Afterpay.

Rather than paying one lump sum or putting it on a credit card, he opted to split up the cost of his exercise gear, clothes, pillows and a watch into installment payments due every two weeks or every month. Stanton felt secure financing his purchases with 0% interest BNPL loans because he knew he would be able to make his installment payments on time and in full.

"Buy now, pay later" loans — also known as point-of-sale loans — offer consumers the ability to pay off their purchases over a fixed period of time with installment payments typically due bi-weekly or monthly. 

If you've shopped on the websites of Target, Walmart, Sephora or ASOS recently, you've probably noticed the BNPL option whenever you get to the checkout page. Square's recent acquisition of one popular BNPL provider, Australia-based AfterPay, for nearly $30 billion, points to the growing popularity of BNPL providers. In fact, a recent report by CB Insights predicts that the industry will grow 10 to 15 times its current size by 2025.  

It's easy to see the appeal of POS loans: While traditional credit cards require that consumers pay off their monthly bill in full and on time each month or be hit with high interest rates and late fees, some BNPL loans give consumers loans with 0% interest and no penalties for late payments.

But are these loans as straightforward as they seem? Select spoke with a number of financial experts to see how this new method of financing could negatively impact your credit score, regardless of whether you're a smart credit user making your payments on time and in full every month.

How some POS loans could decrease your credit score

Depending on your loan provider, taking out a POS loan can either increase, decrease or have no impact at all on your credit score. Some of the most popular POS loan providers — AfterPay, Affirm and Klarna — report some loans to the credit bureaus while others don't.

"If reported, a missed payment can be noted on your credit report for up to seven years and will negatively impact your credit score," says Rod Griffin, the senior director consumer education and advocacy at Experian. "At the same time, if a 'buy now pay later' lender reports account information to credit reporting agencies like Experian, and you are managing the debt responsibly, these services can be a helpful way to build credit."

Affirm is one BNPL provider that does report information to Experian on some loans. It doesn't report loans with a 0% APR and four biweekly payments or loans where people were given the option of a three-month payment term with 0% APR. 

For other Affirm loans, the entire loan history is reported to Experian. This means that both positive and negative payment history will be reported to only Experian and not other credit bureaus. Your payment history, the amount of credit you've used, the length of time you've had the credit and any late payments will all be reported to Experian.

If you default on your Affirm loan or make late payments, you risk decreasing your credit score. But your credit score could take a hit even if you're paying your POS loan on time.

There are a few reasons why a POS loan could hurt your score. For starters, there are many factors that make up your credit score, and your score can go down even if you pay your bills on time, if there are other areas that are lacking.

Here are the five factors that make up your FICO score:

  1. Payment history (35%): Whether you've paid past credit accounts on time
  2. Amounts owed (30%): The total amount of credit and loans you're using compared to your total credit limit, also known as your utilization rate
  3. Length of credit history (15%): The length of time you've had credit
  4. New credit (10%): How often you apply for and open new accounts
  5. Credit mix (10%): The variety of credit products you have, including credit cards, installment loans, finance company accounts, mortgage loans and so on

Some of the factors that determine your credit history are the average age of your accounts, the age of your oldest account and how long it's been since you opened an account. (This is one of the reasons many people worry that closing a credit card could ding their score.)

"While the record of on-time payments can boost your credit, you could see a blow to your score from using the [BNPL] service," says Leslie Tayne, founder and managing director at Tayne Law Group. "Every purchase you make with a POS loan is considered a separate account on your credit report that gets closed once you pay off the balance. Since these loans are short-term (generally six weeks), they can bring down the average age of your credit history considerably — especially if you're a regular borrower."

Since 15% of your FICO credit score is determined by the length of your credit history, repeatedly taking out POS loans can decrease your credit score since it lowers the average age of your accounts, Tayne explains.

On Credit Karma, Affirm has a customer rating of 2.9 stars, and reviewers have complained about their loans impacting their credit score even when they're in good standing.

"Each loan, no matter how large or small, will count as a separate account on your Experian credit report. I used Affirm about 15 times, to take advantage of their 0% financing offers. Surprise! Experian's average account age calculation on my credit file dropped from 11 years to about 2 years. This negatively impacts your credit score. Beware," one reviewer wrote.

Affirm does address how its loans can impact consumers credit scores in its help section, noting that how much credit you've used, how long you've had credit, making late payments and your payment history with Affirm could affect your score.

Need a BNPL loan that won't impact your credit score?

Each BNPL loan handles credit checks and reporting to credit bureaus differently.

Although AfterPay does not consider itself a POS provider, AfterPay performs no credit check at all, making it a solid option for people who have poor or bad credit and have a hard time securing a loan otherwise (it also won't improve your credit score). It doesn't report loans to the credit bureaus.

Klarna also does not report information to the credit bureaus on its POS loans, according to Klarna. Klarna will perform a soft credit check, which won't affect your credit score, if you're taking out a 'Pay in 4' loan or a 'Pay in 30 days' loan. Additionally, if a consumer applies for a branded open line-of-credit product offered by Klarna's partner bank, a hard inquiry may be conducted.

Your score won't be affected if you take out an Affirm loan that charges 0% APR and has four biweekly payments or loans where people were given the option of a three-month payment term with 0% APR. If you take out a longer loan with interest, the loan will be reported to Experian.

Before you take out any BNPL loan make sure you're clear on the terms and conditions, so you understand the interest rate and repayment schedule.

Make a point to regularly review your credit report

Everyone should make a point to get into a habit of regularly reviewing their credit reports, especially if you're opening new financial products, whether that's a POS loan or a new credit card.

Due to the pandemic, each of the three credit bureaus — Experian, Equifax and TransUnion — now offer one free credit report weekly. (They each typically offer one free report yearly.) Just go to annualcreditreport.com, a website authorized by federal law, to request your credit report from one of the bureaus. If you have an Affirm loan, you'll want to request your Experian credit report.

There are also a number of free services that allow you to keep track of your credit score. Most credit card companies allow you to check your score on their apps or website. You can also use a free credit monitoring program like CreditWise from CapitalOne or Experian free credit monitoring.

While signing up for a POS loan won't necessarily improve your credit score, there are a few quick ways to improve it. *Experian Boost™, for example, is a free service that offers consumers the ability to connect their utility and streaming accounts to their Experian credit report. This means that if you're timely about paying off your internet, water or Netflix® bill, you could see your FICO® score improve.

Bottom line

Ultimately, POS loans could have an unexpected effect on your credit score. If you don't read the terms and conditions on your specific loan, you might be surprised to find out that even when you're making your payments on time and in full, your credit score could decrease because of the effect these short term loans have on the length of your credit history.

While Stanton has paid off his Klarna and AfterPay loans (both of which aren't reported to the credit bureaus), he still has one Affirm loan left to pay off: a loan that will be reported to Experian. Stanton hasn't seen any changes in his VantageScore in the past year but when he learned about the effect an Affirm loan could have on his credit score, he said, "...damn, I should have looked into this a bit more."

Correction: This article has been updated to correct the amount that Square paid to acquire AfterPay. It has also been updated to correctly reflect which loans Klarna performs a hard inquiry for.

*Results may vary. Some may not see improved scores or approval odds. Not all lenders use Experian credit files, and not all lenders use scores impacted by Experian Boost.

Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.
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