Liz Weston, CFP®
Expanding access to credit is a worthwhile goal. Too many people can’t get a mortgage or payday loan at a reasonable rate because they can’t show a strong credit history. They may pay more for insurance or make large security deposits to get utilities or rent an apartment.
Recently, the three major credit bureaus announced plans to incorporate “buy now, pay later” plans, a very popular type of financing at the point of sale that until now remained largely outside the traditional credit ecosystem, in credit reports.
But no one should expect that buy now, pay later purchases will instantly open the door to better credit. If you want reliable access to the largest number of lenders, building credit through traditional means is still the best route.
Buy now, pay later Loans skyrocket in popularity
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If you recently bought something online, chances are you’ve found a buy now pay later option that offered to split your purchase into a few installment payments. Retailers partner with lenders like Affirm, Afterpay and Klarna to offer payment plans, which typically don’t require a credit check and may not charge interest. With the popular four-payment option, for example, you pay your balance in four equal, interest-free installments due every two weeks. Instead of charging interest, lenders get a percentage of what you spend from the retailer, similar to interchange fees charged by credit cards.
Buy now, pay later services have proliferated as the pandemic shifted much of shopping online, but plans are now available for travel and health care and as an option at some brick-and-mortar retailers. Nearly 100 million people used buy now, pay later last year, says Liz Pagel, senior vice president of consumer lending at credit bureau TransUnion.
Like all easy credit, these plans can tempt people to overspend. Buy now, pay later loans are also largely unregulated and lack the consumer protections that cover credit and debit card purchases. In addition, the Consumer Financial Protection Bureau is investigating how buy now, pay later lenders use payment and purchase data they collect from customers.
Credit bureaus are still working out the details
Credit bureaus want access to that payment data, hoping they can give more traditional lenders insight into how these borrowers might handle other types of credit.
The offices are not being altruistic, of course. They are private businesses that want to profit. But in doing so, the bureaus could help expand access to credit by identifying borrowers likely to be able to handle credit among the millions of “invisibles,” people who don’t have a credit history — as well as those who have too little information on file to generate credit scores. TransUnion’s Pagel has called buy now, pay for data later the biggest financial inclusion opportunity in a generation.
How offices will address this is still a work in progress. Two of them, TransUnion and Experian, say the information won’t be included in regular credit reports for now, but lenders will be able to request it. The third bureau, Equifax, says it will incorporate the data into people’s credit reports.
But the leading credit scoring company, FICO, is still studying buy now, pay later data to see how well it predicts how people might handle other credit. There is not even agreement between the offices on whether the loans should be treated as revolving debt, like credit cards, or as installment loans, which tend to last much longer.
“It’s a very important question because how it’s reported makes a definite difference in the impact it will have on the score,” says Ethan Dornhelm, FICO’s vice president of scores and predictive analytics.
How you can build better credit now
If you are currently trying to build or rebuild credityou probably don’t want to wait for these details to be worked out.
Consider asking someone responsible with credit to add you as an authorized user to your credit card. Other options include a credit building loan or a secured credit card from a lender that reports to all three bureaus.
Credit-building loans, offered by credit unions or online, put the money you borrow into a savings account or certificate of deposit that you can claim after you make all your monthly payments. A secured credit card generally provides you with a line of credit equal to the deposit you make with the issuing bank. Of course, these aren’t instant fixes for bad or no credit, but they are proven ways to expand your own access to credit now.
This article was written by NerdWallet and originally published by The Associated Press.