What Is Buy Now, Pay Later? How BNPL Works (2023)

For the better part of the past century, when a customer wanted to buy an item on credit from their favorite stores, they had two main options. The first was putting the purchase on a credit card. The second was using a layaway program, which allowed them to reserve an item at the store, pay for it in installments, and receive the merchandise once it was paid for.

Today, credit cards have a solid foothold—79% of the US population has at least one in their wallet—but layaway plans are becoming a thing of that past. They’re being replaced by a new payment option: buy now, pay later (BNPL) programs managed by third-party credit specialists. And while retailers don’t get to charge interest to customers using BNPL (in fact, they are charged a fee by the BNPL vendors), they are making up for it in increased sales volume. BNPL has also helped equalize the credit market. It enjoys surging popularity with those who, for various reasons, do not typically purchase items with a credit card.

What is buy now, pay later (BNPL)?

A buy now, pay later plan (BNPL) is a loan offered to a customer at the point of sale so they can purchase merchandise on credit but without a credit card. Popular options include Shop Pay Installments from Shopify, Affirm, Afterpay, Sezzle, PayPal, and Klarna. Many will run an instant soft credit check on the customer (the type that doesn’t affect your credit score), and then release funds for a point-of-sale loan. Customers have different options for paying off the loan balance, which typically depend on the company used and the amount borrowed; some payment options incur interest, but others do not, and some companies charge late fees or fees for missed payments. BNPL companies may offset the lack of interest charged to the consumer with a fee that they charge the retailer.

How BNPL works

Here is how the BNPL process works for both consumers and retailers.

• A customer shops as normal and begins the checkout process. If you’re a customer, you start the BNPL process as you would any other ecommerce transaction. You shop your favorite online stores, select merchandise, and prepare to pay.
• The retailer’s chosen BNPL vendor presents the option to buy now and pay later. During checkout, the customer will have the option to purchase using BNPL, along with other purchase options like credit or debit cards.
• The lender runs a soft credit check on the customer. When the customer opts to purchase their items using BNPL, they enter some personal details with the BNPL lender (such as a full address and Social Security number). The lender immediately runs a soft credit check on the customer to get assurance that they will eventually pay back their loan based on their credit history. This type of credit check does not get reported to the credit bureaus, so it will not dent credit scores like a full credit check might.
• The BNPL vendor charges a fee to the retailer. The BNPL vendor will take a percentage of the retail transaction, and this is billed directly to the retailer. The fee (which typically ranges between 2% and 8%) gets deducted from the sum the BNPL lender remits to the merchant. This is similar to the arrangements that traditional credit card companies have with retailers.
• The customer pays off the balance over time. Most BNPL vendors offer interest-free payments if a customer pays their full balance in a short period of time (typically 30 days). If customers need more time to pay down their balance, the lenders offer different payment plans with different interest rates. Much like with a credit card, the faster the customer pays off the bill, the less total interest they pay.

4 advantages of BNPL for customers

As a consumer, you enjoy several potential benefits when using a BNPL service.

• It’s an equalizer for those without credit cards. A significant minority of customers (about 20%) do not have a credit card, and the majority (55%) of those with a credit card have maxed out at least one card. A BNPL service offers many of the same benefits as a credit card but for smaller, individual purchases. You can even use a BNPL service like a credit card by requesting a virtual card number in advance of your purchase. This card number will cover the exact amount of money needed to complete your purchase. You do all this on the BNPL vendor’s website or via its smartphone app.

• Flexible payment options. Most BNPL services offer options to customers at the point of sale. As a customer, you can pay the full purchase price using the BNPL service, or you can split your purchase between BNPL and some other payment source (like a debit card).

• Options for interest-free payments. If you choose a short loan period and make your payments on time, you can borrow money without paying any interest.

• Soft credit checks have no impact on your credit. MostBNPL vendors run soft credit checks on their clients to affirm their eligibility for a loan. Unlike a hard credit check, this will not dent your credit score. On the other hand, if you are late in your payments to your BNPL vendor, this does get reported to credit bureaus, much like when you’re late on credit card payments.

6 popular BNPL services

Retailers regard buy now, pay later services favorably because they’ve been shown to boost overall sales volume. As a result of this retailer preference, there are more viable BNPL services than ever before. Here are six well-regarded options.

1. Shop Pay Installments

Shopify offers a robust BNPL service called Shop Pay Installments. It does so in partnership with Affirm, using the same network of lending partners. When merchants choose Shopify as their ecommerce vendor, they can use Shop Pay Installments to let their customers pay their balance in four interest-free installments, while the merchant still receives the full balance at the time of purchase. Shop Pay Installments grants online small businesses the same BNPL benefits enjoyed by major retailers, including a larger average order value and less cart abandonment.

2. Affirm

Affirm is among the biggest BNPL vendors, and it is prominently offered as a payment option at big retailers like Amazon and Target. For short-term loans (four payments with two weeks between each payment), Affirm charges no interest and no fees. Longer-term loans require interest payments (ranging from 10% to 30% APR, depending upon your credit) but still no fees. If you are shopping at retailers that don’t already partner with Affirm, there’s still a good chance you can use the service via a virtual card.

3. Afterpay

Founded in Australia, Afterpay is now owned by US-based Block (formerly Square). It is even larger than Affirm, as it partners with over 100,000 retailers. One of Afterpay’s prominent features is a smart credit limit tool that creates a spending limit for shoppers based on their personal credit history. This ideally prevents them from spending more than they can pay back. It also offers consistent reminders to make payments, and its virtual card service is easy to use. Unlike Affirm, Afterpay does charge late fees, but these will never apply if you make your payments on time. Its interest rates fall into the same 10% to 30% range as Affirm.

4. Sezzle

Sezzle is a BNPL company with a signature feature that lets customers push back payment due dates by up to two weeks. Sezzle does require a 25% down payment on all purchases, but you can pay off most loans without owing interest. Sezzle actively cultivates younger users; it describes itself as “on a mission to financially empower the next generation.” It has over 44,000 retail partners, but it’s less popular among the largest retailers (one notable exception is Target, which does offer Sezzle as a payment option).

5. PayPal

PayPal is probably better known as a secure online payment system or as a person-to-person cash transfer app, but PayPal is also a BNPL lender. Its signature lending product is an interest-free service called Pay in 4, which breaks transactions into four scheduled payments. PayPal limits this service to purchases between $30 and $1,500. By contrast, Affirm will loan up to $17,500. The advantage to using PayPal is that it boasts nearly 30 million active merchant accounts, which means it can be easily used without taking extra steps like applying for a virtual card number. PayPal’s standard interest rate is roughly 24% APR.

6. Klarna

Klarna was founded in Sweden in 2005. It now reports over 85 million customers, and it partners with hundreds of thousands of merchants worldwide. Depending upon the type of borrowing you do, Klarna may run a soft credit check or a hard credit check. Rather than set strict borrowing limits, Klarna uses a proprietary metric it calls Purchase Power. Its official website describes Purchase Power as “an estimated amount based on factors such as your payment history with Klarna and your outstanding balance.” If you have good credit and a solid payment history, you may be eligible for larger point-of-sale loans from Klarna than from most other BNPL vendors. When you do pay interest, it will max out at 25%.

Final thoughts

As a retailer considering a BNPL option, you will have to balance two considerations. One is the fees that BNPL vendors charge on each purchase. The other is the increased shopping carts of customers who use a BNPL service.

Most BNPL retailers do not publicly disclose their merchant fees, but they typically range between 2% and 8% of a customer’s purchase amount. This puts them in the realm of major credit card companies. As such, it may be no more expensive for a merchant to accept a BNPL service than to accept credit cards. And much like with credit cards, a BNPL service can inspire customers to spend more. Retailers from Macy’s to Peloton to Rue21 have reported notably increased sales among customers using a BNPL service. For these vendors and many others, the added sales volume more than compensates for the fees they’re paying.