Buy Now Pay Later or “BNPL” shopping has dramatically increased the purchasing power of shoppers, particularly those seeking credit without the hassle of a card application. But what are the dangers of BNPL. Are there any?!
For those born before 1970 and who still carry cash in their pockets, most of this won’t mean much to you. But the reality is that the entire retail landscape is changing at the speed of sound as the digital age continues to take over our lives. According to a recent report from ASIC, the number of transactions across BNPL platforms in Australia has grown from 80,000 in 2016 to 1.9 million in 2018!
So how exactly does BNPL work and why is it such a big deal?
As it turns out, understanding the mechanics of BNPL is a tremendous way to better understand and appreciate the inherent pros and cons it brings with it. Here’s a basic illustration of how BNPL works:
- A vendor wishes to sell a jacket for $96.00.
- A customer wishes to purchase this jacket however $96.00 is a bit out of their immediate price range.
- A BNPL platform will purchase the jacket for the customer for $96 and the customer will receive the jacket.
- In exchange, the customer agrees to repay that BNPL platform in 4 instalments of $25, totalling $100.00.
So, the vendor is pleased because they have received upfront payment for a jacket that the customer would not have been willing to purchase without the support from the BNPL platform. It is due to the way the BNPL platform essentially increases the market for vendors in this way that so many vendors use such a platform in their stores (or online).
The customer is pleased because they have been able to purchase their jacket immediately without forking out $96 upfront and they have been able to spread out their repayments over 4 instalments only costing them $4 extra, the equivalent of 4% interest. The customer is also happy they were able to do this without applying for a credit card and going through the time-consuming and interrogative process of a credit check.
The BNPL platform is VERY pleased. For taking on the credit risk – that is the risk of the customer not repaying the debt, they have made $4 profit. Now this may not seem like very much money, however think of it this way. The customer has paid $4 interest over 4 instalments spanning a total period of 4 weeks. That $4 is the equivalent of 4% interest per month, which equates to 48% interest per annum!
Therein lies the beauty of BNPL platforms. The perception of BNPL is that it costs the customer very little – which is true in a strict sense. However, if you asked a customer if they would like a loan on a new jacket for 48% interest per annum, do you still think they would sign up?
Now when you multiply this strategy by hundreds of thousands of transactions every year, that is a lot of 48% per annum interest repayments the BNPL platform is receiving. And if a customer does default on a loan repayment? The BNPL platform bans them from using their service and is quite happy to wear the $100 loss because they are making so much money from other customers. This differs to the big banks credit policies which are usually for a far greater loan amount.
So is there a danger to using a BNPL platform? It depends. The good news is that unlike applying for a credit card and a debt facility in the thousands of dollars, the quantity and sheer severity of the credit risk both to the BNPL platform and the customer may be much lower than other loan facilities.
However, it can make spending your money a whole lot easier and certainly the psychology of “low interest loan repayments” may be misleading and can have a negative effect on consumers if used without caution.
You can read about a whole heap of other benefits and drawbacks relating to BNPL platforms in this article.
At Wealth Depot, our advice is to always think about the cost of credit in a way that allows you to compare it and to think about the pros and cons of every money-related decision you make.
If you are willing to pay higher interest over a short period of time to avoid the burdensome process of credit approvals and if it is just for an occasional purchase, then that may be an entirely sensible approach to take. But we urge you to think about what exactly it is costing you.