Mastering 'Buy Now, Pay Later (BNPL Services): 7 Ways to Stay Debt-Free

When you're living paycheck to paycheck, a treat every now and again seems a righteous gift to yourself. Something earned, even though you must make the payments over time to get back to zero.

This is the idea behind the Buy Now, Pay Later services that are offered everywhere these days. Breaking a single purchase down into four easy payments seems so manageable. A payment of $25 or $30, or $40 per payday seems small until it isn't.

The Appeal of Instant Gratification: the Birth of BNPL

BNPL or Buy Now, Pay Later financial services exploded onto the market in 2015. The idea was to break down any purchase (with participating businesses) into four easy payments over eight weeks. There was no interest on the payments and it seemed like a better, shorter-term option than credit cards.

BNPL services were not classified as credit cards, so no guardrails were put around them for undisciplined spenders. And this is where the trouble started.

BNPL services rapidly expanded from a single provider to multiple providers under the names Affirm, Afterpay, Sezzle, PayPal Pay In 4, Klarna, Zip, and a host of others. They were advertised as having little or no costs associated with them to purchasers. That doesn't make them cost-free.

Individuals may have the service offered to them for free, but there will be penalties for any payments that are missed. Retailers generally pay a 2%-6% fee to the service provider but they get their money upfront. If you default, the BNPL service will chase you, not your local service provider.

This makes it so easy to purchase by incurring small, short-term debts.

The Hidden Pitfalls: Issues Surrounding BNPL Services

But major issues surfacing around BNPL service providers were not initially apparent.

1) Credit Card companies must do at least a cursory check on whether you can pay back any debt you incur on the card. If they provide credit to someone who can clearly not pay it back, they can be held liable and the debt cancelled.

BNPL services do not have to do that. Their method was to charge what you want to your account and have you manage the debt payments yourself.

2) BNPL allow you to pay off your purchase over four payments across eight weeks. However, punishing interest rates can apply if those payments are not met. Up to 36% sometimes, which is higher than most credit cards.

3. Uncontrolled spending: Since there are no limits on what you can charge on your BNPL account, it could tempt users into excessive spending, leading to insurmountable debt.

4. Unregulated sector: BNPL services currently escape the purview of many traditional credit regulations, leaving consumers unprotected. However, guidelines and new standards are about to be applied to BNPL service providers in Australia (circa 2023).

5. Hidden costs: BNPL services have associated costs despite appearing cost-free. Late payment fees, account-keeping fees, and enrollment fees can significantly inflate the cost of a purchase.

6. Financial strain and mental health issues: The stress of high-interest debt, late payment fees, and possible spiralling debt could severely impact users' mental health, a cost that goes beyond the financial realm.

Case stories abound of people losing control of their repayments and ending up in severe financial distress. One man purchased all his Christmas gifts using BNPL and then lost his job. Another was using as many as 7 BNPL service providers and ran up debts of over $30,000.

There are fears that a growing number of Australians are falling into a debt trap using BNPL services for everyday expenses and being unable to repay.

Dodging the Debt Trap: Responsible Use of BNPL Services

So how do you avoid this? Firstly, understand that when you make a financial obligation, you are legally bound by it. Credit needs to be used responsibly. Here are seven ways you can avoid the BNPL debt trap.

1. Set a Budget and Stick to It: It's essential to have a clear budget in place and ensure that any BNPL purchases fit within this budget. Otherwise, spending more than you can afford to pay back can be easy.

2. Understand the Terms and Conditions: Make sure you fully understand the repayment terms, including when payments are due and what happens if you miss a payment. Some BNPL services charge late fees or interest if you don't pay on time.

3. Prioritize Essential Purchases: Use BNPL services for necessary items rather than impulse purchases. This can help ensure you're using the service responsibly and not accumulating debt on unnecessary items.

4. Track Your Payments: Record all your BNPL purchases and when payments are due. This will help you manage your cash flow and ensure that you have enough money to cover your repayments.

5. Avoid Multiple BNPL Services: Using multiple services can make it harder to keep track of payments, increasing the risk of missed payments and debt accumulation. Stick to one service if possible.

6. Pay Off Balances Early If Possible: If you have the means, consider paying off your BNPL balance ahead of schedule. This can help you avoid the risk of missed payments and potential fees.

7. Maintain a Healthy Credit Utilization Ratio: Although many BNPL services don't report to credit bureaus, some do. It's important to ensure you're not using much of your available credit, as this can impact your credit score. Ideally, you should aim to use less than 30% of your available credit.

Remember, it's essential to consider your own personal financial situation before using BNPL services. While they can offer convenience and flexibility, they also have the potential to lead to financial stress if not managed correctly.