BNPL loans soon to impact credit scores

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    In New York, significant changes are on the horizon for millions of Americans who frequently use ‘Buy Now, Pay Later’ (BNPL) loans for purchases ranging from clothing and furniture to concert tickets and takeout. FICO, a well-known credit scoring company, has announced the release of a new credit score model that will incorporate BNPL loans, offering a more comprehensive view of consumer credit behaviors. Traditionally, FICO scores have played a crucial role in assessing a borrower’s creditworthiness, yet these short-term loans were previously not factored into consumer credit scores. The financial landscape began shifting when BNPL company Affirm initiated voluntary reporting of these loans to Experian earlier this year.

    FICO’s updated scoring model aims to give lenders better insights into consumers’ repayment habits, making it available this fall. However, the transition will be gradual since not every BNPL provider shares their data with credit bureaus, and not all lenders may adopt the new scoring model quickly. Adam Rust, who leads financial services at the Consumer Federation of America, notes that the widespread adoption of these changes might take some time, given the voluntary nature of data sharing and adoption.

    BNPL loans have previously been absent from credit scores because they differ from traditional lending. Typically, consumers repay these loans in four interest-free installments over six weeks, often involving minimal credit checks. The major credit reporting bureaus have yet to establish a common approach to incorporating these loans due to their unique format. FICO, leveraging data from various bureaus, is independently rolling out a pilot score that includes BNPL loans.

    The integration of BNPL loans into credit scores is a response to the growing role these loans play within the U.S. financial ecosystem. Advocates view these loans as safer options compared to credit cards, but concerns have arisen about “loan stacking,” where consumers may accumulate multiple overlapping loans. The lack of visibility and transparency has spurred warnings about “phantom debts,” obscuring consumers’ true financial health. FICO intends for their updated model to accurately capture this sector’s impact on consumer finances.

    This new development primarily aims to expand credit access responsibly. Many BNPL users are younger individuals or those without substantial credit histories. A collaborative study between FICO and Affirm revealed that the new scoring model usually led to stable or improved scores for individuals holding five or more BNPL loans. Timely repayment of these loans could enhance a borrower’s credit score, potentially facilitating increased access to mortgages and car loans. Previously, BNPL loans rarely improved credit scores, although missed payments could still negatively impact them.

    Currently, a significant number of consumers are experiencing declining credit scores, largely due to the reinstatement of student loan payments. As a result, many borrowers are struggling to maintain regular payments on these loans. There are concerns that incorporating BNPL loans into credit scores might inadvertently impact individuals who are already credit-constrained. Nadine Chabrier from the Center for Responsible Lending highlights these potential risks, noting that the consequences of this integration remain uncertain.

    Data indicates that frequent BNPL users often have revolving credit card debts and lower overall credit scores. Women of color, in particular, are more likely to rely on these loans, suggesting that the affected demographic may already face credit vulnerabilities. According to Rust from the Consumer Federation of America, although the changes in credit scoring models are substantial, they are unlikely to dramatically shift the credit profiles of users with established credit histories. The real benefit lies in creating a more accurate representation of consumers’ debt levels, preventing them from excessive borrowing.

    As the BNPL sector continues to influence consumers’ financial environments, increased transparency could lead to better underwriting practices and more informed borrowing decisions. By addressing issues like “phantom debt,” there’s hope to steer consumers clear of unsustainable debt levels.