Financial Face-Off: Buy now, pay later vs. credit cards — what makes better financial sense?

As you head out to stores or hunt for the perfect stocking stuffer online, what’s the best way to pay for those purchases? Should you use buy now, pay later (BNPL) or a credit card?

Why it matters

Buy now, pay later, where a purchase is typically divided into four payments paid over several weeks, has exploded in popularity. You’ve probably seen offers to use BNPL pop up during checkout when shopping online. Signing up is quick and easy. But some consumer watchdogs say it’s a little too easy to get a BNPL loan. BNPL isn’t as closely regulated as credit cards are. The Consumer Financial Protection Bureau and Consumer Reports have both identified some problems with BNPL and called for more consumer protections. 

While most shoppers were satisfied with their BNPL experience, about one-third said they ran into problems, according to a Consumer Reports survey. Shoppers reported trouble with returns or refunds; some incurred late fees and overdraft penalties (which can happen when a BNPL payment is attached to a debit card, and BNPL users are more likely to incur overdraft fees than people who don’t use BNPL, a Morning Consult analysis found ). Other BNPL users became overextended on BNPL loans and couldn’t keep up with their payments, Consumer Reports found.

“As consumer advocates we feel that the way things are now, BNPL is more likely to hurt you than help you,” said Chuck Bell, the advocacy programs director at Consumer Reports and author of a recent white paper on BNPL. “You could get dinged for any loan payments you may miss.” While BNPL can work for people who keep up with their payments and avoid late charges and fees, it may not be the best option for people who are trying to build their credit, Bell said.

Another side effect of BNPL: regret. About 20% to 50% of BNPL shoppers regret their purchases, according to the CFPB.

The verdict

Go with the credit card and charge it.

My reasons

Make no mistake, credit-card debt is extremely expensive right now. The average annual percentage rate on a credit card hit 19.59% in early December, according to Creditcards.com, the highest since CreditCards.com started tracking APRs in 2007. If you carry a balance, it can build up fast. Digging out of credit card debt can take years.

“There’s a saying in the industry that credit cards are like power tools,” said Ted Rossman, a senior industry analyst at Bankrate.com. “They can be really useful or they can be dangerous.” Before you start using a credit card, you need to know yourself, he cautioned.

But there are some points in favor of using credit cards over BNPL. The biggest is that using a credit card helps you build your credit, while BNPL doesn’t. BNPL can be appealing because it’s so easy to get started with (it typically doesn’t require a “hard credit check”) but the flip side of that is that it doesn’t help you improve your credit score, Rossman said. “It’s a little bit of the chicken and the egg kind of thing. You may have been drawn to it because you don’t have great credit, but it doesn’t necessarily get you closer to great credit,” he said.

Because BNPL is still relatively new in the U.S., there are not yet hard and fast rules on how BNPL providers report users’ payment history to credit reporting agencies. Many BNPL companies don’t report this information at all, which could have “downstream effects on consumers and the credit reporting system,” the CFPB noted. “It could be bad for BNPL borrowers who pay on time and may be seeking to build credit, since they may not benefit from the impact that timely payments may have on credit reports and credit scores.”

The lack of reporting can also mean lenders (both BNPL and non-BNPL) don’t have a complete picture of how much debt a shopper has. That means BNPL providers may continue to offer loans to users who already have multiple BNPL loans, putting them in danger of not being able to pay the money back, according to the Consumer Reports white paper. This can lead to “loan stacking,” where users take out multiple BNPL loans at once, and in some cases, that results in unpaid loans being sent to debt collectors and potentially ending up on credit reports, where they can stay for seven years, according to Consumer Reports.

“Of those who missed one or more BNPL payments, 21% said their debt was sent to a collections agency, and 15% said the debt appeared on their credit report,” according to Consumers Reports. Almost half (43%) of people who use BNPL have subprime credit scores, compared to 24% of people who don’t use BNPL, according to the report.

Building credit is a key step in improving your long-term financial well-being. Your credit score has ripple effects across your life. It can determine whether you qualify to rent an apartment, as one new member of Congress recently learned. Your credit score decides how big of a mortgage you can get and how cheap or expensive it will be to borrow that money. Credit is also a factor in how much you pay for car loans and home and auto insurance. It can play a role in your job prospects (some employers do credit checks) and even affect your dating life. 

“There are few things in life that are more expensive than crummy credit,” said Matt Schulz, chief credit analyst at Lending Tree. It can cost you thousands and thousands of dollars over the years in interest and fees, he noted. “Good credit is one of those things that doesn’t always matter, but when it does, it really really does.”

Credit cards aren’t required to build your credit score, but using them and paying the bills on time definitely helps. (Tip: If you’re nervous about opening your first credit card, start by using one just to pay for one cheap monthly subscription on autopay. That’s an easy way to build up a record of responsible credit use, Schulz said.)

Credit cards also typically offer more customer service perks than BNPL. Returns are typically easier, and some offer purchase protection that will replace a stolen or damaged item for a certain period. Some come with travel insurance that will refund you if a trip is canceled. And then there is the world of credit-card points, rewards and cash back. (Some BNPL companies have also started to offer rewards programs.) Some credit cards also have special offers like sign-up bonuses, or 0% interest for an introductory period, or low APRs if you’re switching a balance. 

Is my verdict best for you?

On the other hand, as mentioned above, credit-card debt can be a costly financial burden. “A lot of people have been traumatized by credit cards,” Bell said, and that makes BNPL more attractive to some shoppers. 

“BNPL takes a lot of heat for a lot of reasons and deservedly so, but the truth is, if you use BNPL wisely it can be a really good deal,” Schulz said “It gives you a short-term interest-free loan that can help people who just need a little bit of extra time to purchase something.” (Some BNPL services do charge interest; check the fine print.)

With BNPL, there’s a light at the end of the debt tunnel, because you’re paying off your purchases in a few set installments. That set-up may be appealing to people who’ve been burned by paying seemingly endless student loans, Rossman said.

But proceed with caution. One misconception about BNPL services is that they’re all the same, Schulz said. Each one has different terms, so make sure you know what you’re getting into before you sign up.

The BNPL industry, which published a response to the CFPB’s report, says it’s offering a no-fuss, no-muss option. “Consumers are choosing buy now, pay later because it is a lower-cost, easier-to-use alternative to legacy credit products,” a spokesperson for the Financial Technology Association, a BNPL trade group, told MarketWatch. “BNPLs are zero-to-low interest options with simple repayment terms over the course of six to eight weeks. Unlike legacy products, BNPL plans cut late users off from the service immediately, so consumers don’t get trapped into cycles of revolving debt.”  

Related: MarketWatch Best New Ideas in Money Podcast: Buy now, pay forever?

Tell us in the comments which option should win in this Financial Face-off. If you have ideas for future Financial Face-off columns, send me an email at lalbrecht@marketwatch.com.