Buy Now, Pay Later (BNPL): the truth about 0% interest
And how does BNPL compare with traditional loans and credit cards.
Buy Now, Pay Later (BNPL) is becoming a popular mode of finance for consumers these days. It’s being used to fund everything from vacations to groceries to gym memberships.
As the name suggests, BNPL means you buy products now but pay the amount later (in monthly installments). Yes, just like a traditional loan. But what separates BNPL from a traditional loan is the fact that BNPL doesn’t come with interest. For example, if you buy a product priced at $1,000 with BNPL, you don’t need to pay interest. Just the monthly installments. Let’s say $250 equally in 4 monthly installments. That’s $250 x 4. Yes, the same $1,000. No interest costs here.
Now, you must be wondering how BNPL companies (like Klarna) make money if they don’t charge interest?
To understand this, let’s go through an example of a typical BNPL transaction:
Let’s say you’re looking for a laptop to buy online. You found a great laptop for $1,000 in 2 stores - ABC Electronics and DEF Electronics. Same price and same delivery time.
But DEF Electronics offers a BNPL payment option from a BNPL company (like Klarna). So, you don’t need to pay the complete $1,000 at the checkout. On the other hand, ABC Electronics doesn’t have the BNPL payment option.
The BNPL offer from DEF Electronics is too good to ignore. So, you decide to go ahead with purchasing the laptop on DEF Electronics’s online store. You just need to pay $250 in 4 monthly installments ($250 x 4 months = $1,000). No interest costs of any kind.
You complete the checkout, pay $250 (the first installment), and expect to receive the laptop within the next 2 days.
DEF Electronics receives $950 from the BNPL company instantly. Why $950? Because $50 is charged as a “merchant fee” by the BNPL company. Fee for processing payments and, most importantly, for helping you buy at DEF Electronics instead of ABC Electronics. Had it not been for BNPL, it is likely that you might have bought the laptop at ABC Electronics. Makes sense? Even if you remove ABC Electronics from the equation, the $1,000 outright payment made have made you resistant to buy instantly.
Now a fee of $50 on $1000 is almost 5%. So, the merchant (DEF Electronics) has to pay huge fees of 5% if it wants its online store to convert visitors into customers and sell more.
This $50 fee is the revenue for the BNPL company.
Note, if you don’t pay the rest 3 monthly installments on time, the BNPL company may charge penalty and interest.
This is how a typical BNPL transaction happens.
Now, you must be wondering: why take the BNPL payment option when a credit card is available?
Great question.
Credit cards also come interest-free if you pay your outstanding amount within the due date, right? Then why is BNPL getting so popular? Don’t consumers already have credit cards?
Well, that’s because with credit cards, you need to pay your outstanding amount (as in the statement) within 30 days or else you risk attracting a high interest of 18%. Take the above laptop purchase as an example. You need to repay $1,000 by the next due date or else be prepared to pay a high interest cost. Compare that with BNPL, you need to pay $250 each month for the next 4 months. Yes, more time to repay and so much more clarity.
Also, credit cards are like recurring credit. You clear the outstanding amount, and the credit cycle starts again. Whereas, BNPL is transaction based.
Now, from the business point of view, what’s more profitable for a finance company or a bank: issuing credit cards or offering a BNPL option. Of course, they don’t need to choose and can offer both products. This is just a comparison for better understanding. Let’s find out.
Issuing credit card:
Transaction: Customer buys a $1,000 laptop
Merchant fee (processing/interchange fee): 2% ($20). The retailer pays this to the finance company.
Revenue for the finance company: $20 (merchant fee) + 18% interest if the customer doesn’t pay by the due date + annual card fees.
Risk: Full credit check before issuing card (like checking credit rating or score). So usually less risky.
Profitability: Stable and recurring income from merchant fee + interest + fee
Providing the BNPL option:
Transaction: Customer buys a $1,000 laptop, splits into 4 payments of $250 each.
Merchant fee: 5% ($50). The retailer pays this to the finance company.
Revenue for the finance company: $50 (merchant fee) + 18% interest if the customer defaults on monthly payments.
Risk: AI-driven real time risk assessment of the customer during checkout. Less reliable than the robust credit profile checks that are done before issuing credit cards.
Profitability: Higher merchant fee, but the default risk is also higher (since a robust credit profile check is not done before providing BNPL, customers may default on payments).
So, from the finance company’s or bank’s point of view, BNPL is a profitable offering, but the default risk is also higher than compared to credit cards. Higher risk and higher rewards are the name of the game.
And from the retailer point of view, I don’t think they’ve a problem in paying a higher merchant or processing fee if that higher fee results in more sales.
What are your thoughts? Comment below.