The pandemic has made us all creatures of comfort when it comes to shopping online. With 1-click purchases, meal subscriptions, and free next-day deliveries, it’s hard to imagine life otherwise. 

Then there's BNPL, or Buy Now Pay Later services. You'll often find these listed as payment options at popular retailers such as ASOS, Samsung, and GAME.

The BNPL model itself isn't exactly revolutionary. The concept of credit can be traced to the pre-industrial era, but these new payment services shake it up by offering customers interest-free loans.

Swedish brand Klarna may be the first to spring to mind, but there are others too, such as Clearpay, LayBuy, and PayPal Credit. Each works slightly differently, but promises the same thing: the convenience of splitting or delaying payments, without interest – and in the case of Klarna, without late fees either.

So why wouldn’t you bite? Many have. BNPL in this iteration saw unparalleled growth through 2020. The BBC reported that five million people in the UK used BNPL services last year, amounting to £2.7Billion in sales. The same article points out roughly £4 of every £100 spent in the UK is from such services. 

But it’s not all rosy. There are consequences to relying on BNPL. Here, we’re going through how Klarna works, the risks, and whether you should use it.

How does Klarna work? 

Klarna has three payment options.

The 'Pay in 30 Days' model is just what it sounds like: you receive your order without paying upfront, but have up to thirty days to pay. You can choose to pay it off earlier if you like, or pay a fee to extend the due date. See the rates across different regions here

Alternatively, ‘Pay in 3’ lets customers split the cost into three equal installments. You pay the first installment at checkout and pay the remaining installments 30-days apart. 

Klarna Checkout at Samsung
Samsung allows customers to pay with Klarna at checkout.

Both of these payment options are interest-free, and neither impact your credit score – but there are other risks if you struggle with repayment, which we'll go into below.

The final payment method is via 'Klarna Financing', the only traditional credit option from Klarna that’s regulated by UK’s Financial Conduct Authority (FCA). The FCA oversees the financial services industry to ensure stability and healthy competition, while also protecting consumers from harm.

Klarna financing allows customers to pay off costs between 6-36 months with an annual interest rate. You make the monthly payments online or through your bank in the same way you would for a credit card. 

You would also need to do a hard credit check. 

What the heck is a hard credit check? 

Before we get into that, let’s look at soft credit checks. Klarna, and other BNPL schemes, are popular because they ultimately make it easy to get a loan. To qualify for the Pay in 3 and Pay in 30 Days options, Klarna does what's called a 'soft credit check'. These are not publicly visible to other lenders and won’t damage your credit score.

A hard credit check does go on your credit report. Once you’ve applied, other lenders can see whether or not it was approved, and typically this marks your credit history for a year.

Multiple hard credit checks in a short period of time look bad to credit lenders. It suggests that you may be struggling to pay bills and are trying to sign up for several credit cards.

Should I use Klarna?
Klarna allows customers to spread costs from retailers or via the Klarna app. Screenshot from Klarna's site.

The biggest risk: BNPL services can lead to debt 

Klarna makes it easy to pay for that shiny new iPhone 12 Pro Max you’ve been eyeing – which is also what makes it dangerous.

Just as easy as it is to delay your payment or split it up, so too is falling into debt, especially if BNPL becomes your go-to method of payment. Consumer support group Citizens Advice found that in the last year, 4 out of 10 BNPL users were struggling to pay off their purchases. 

While soft credit checks are easier to pass, it doesn’t really protect customers who already have financial difficulties or are loaning from other sources. Some BNPL services such as ClearPay don’t even do a soft credit check. 

This is why there’s been a big push to regulate BNPL services – which presently go unregulated as they do not charge interest like traditional credit lenders.

In February 2021, the FCA commissioned a major investigation into “unsecured credit" in the 68-page Woolard Review. The Review proposes a regulatory framework to protect consumers from the risks of BNPL services, including more stringent credit checks.

The paper, chaired by Christopher Woolard, the former Interim Chief Executive of the FCA, points out that customers can potentially fall into £1000 debts combining different BNPL services, and many customers don't even know that BNPL services lack financial regulation.

To make matter worse, Klarna, LayBuy, and Openpay all send debt collecting agencies after customers who aren’t able to pay. 

Wollard Review - Summary of BNPL credit agreements
The Woolard Review proposes BNPL providers do more stringent credit checks. Better BNPL regulation would allow BNPL users to go to a financial ombudsman if they were to run into any problems. Source: Woolard Review (page 45)

Should you use Klarna (or other BNPL programs)? 

Our advice is simply: use it only if you know you can pay on time. If you can pay the full cost upfront, just do it. Why bother locking yourself into a financing option that can potentially become problematic if you’re suddenly unable to pay it back? 

Ensure that the retailer isn't imposing Klarna or other BNPL options on you. The Woolard Review also pointed to cases where customers unwittingly signed up for BNPL services because it was pre-selected as the default payment option.

Most BNPL users also end up opting for the service at the last minute. A study conducted by Which? In October 2020 found that 26% of users didn’t intend on using a BNPL, until it “popped up at checkout”, while 18% said they only used the service because it included a discount.

So think carefully before you sign up (though if you’re reading this, you obviously have). Klarna and its ilk are useful if you really need to delay payment, but treat it just as you would any other loan.

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