Buy Now, Pay Later Comes at a Price: Credit Score Risks You Need to Know (Plus: $124k Windfall Tips)

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What would you do with a windfall?

Blow it all on a trip around the world, buy a fancy car, or maybe pay off student loans and save for retirement.

This episode, we're helping a listener make some responsible and fun choices.

Welcome to NerdWallet's Smart Money Podcast, where you send us your money questions and we answer them with the help of our genius nerds.

I'm Sean Piles.

And I'm Elizabeth Ayola.

Later on this episode, we're going to be looking at what to do with a financial windfall.

But first, we have our weekly Money News Roundup where we break down the latest in the world of finance to help you be smarter with your money.

Our news colleague, Ana Hilhoski, is back to talk about a new change to credit scoring that shoppers are going to want to know about.

Welcome back, Ana.

Great to be here, Sean and Elizabeth.

And yeah, that's right.

Soon your credit reports will reflect your buy now, pay later purchases.

But first first off, I want to back up and say if you haven't heard of or use it before, Buy Now Pay Later or BNPL is a type of short-term installment loan that lets buyers pay a little at a time for a bigger purchase.

If you've made a recent purchase online, you've probably seen BNPL providers like Affirm, Afterpay, and Klarna on the checkout screen.

Right.

And BNPLs have gained a ton of traction over the last few years.

In March, a survey conducted by Harrispoll for NerWallet found that more than half of Americans surveyed use Buy Now Pay Later services.

And among those, nearly one in four say they currently owe money to a BNPL service provider.

But there's a big change starting soon for BNPL users.

Those loans are going to be integrated into your FICO score.

Now, this is new.

So to learn more about BNPL and what the FICO model means for consumers, we have Jackie Belling, a personal loans writer and NerveWallet's resonant authority on BNPL.

Jackie, welcome to Smart Money.

Thanks for having me.

So to kick off our conversation, I'm hoping you can explain more about how BNPL loans work.

You can think of BNPL as a modern-day layaway plan.

When you go to buy something with BNPL, which you can do online or in stores, you'll pay a fraction of the cost up front and then pay the rest later, hence buy now, pay later.

The most common plan is what's called a pay-in-for, which divides the total cost of your purchase into four equal installments.

So if your purchase is $100, you'll only pay $25 a checkout.

And then you'll have three $25 payments remaining, each due two weeks apart until you've paid in full.

So it's about two months then to pay off a typical purchase.

That's right, about six weeks.

So walk us through the current BNPL landscape and how it's grown in recent years.

Well, BNPL really took off during the pandemic.

People started shopping more online, which is where these plans are the easiest to use because BNPL payment options can be integrated directly into a retailer's checkout flow.

That's why when you go to checkout online at Target, for example, you'll see the option to pay with a firm.

Since 2020, BNPL has only continued to grow and it's really entered the mainstream.

It's estimated that anywhere between 15 to just over 20% of Americans have used BNPL to pay for something.

Even if you're not using it, you probably know about it because the largest retailers in the country, like Walmart, Amazon, Costco, they now have direct partnerships with BNPL providers.

But as the industry has grown, it's also attracted more attention from regulators and consumer advocates who are worried about how people are using BNPL.

So why is there concern about how people are using BNPL?

BNPL isn't regulated right now like traditional credit products, and there's a big concern essentially that people are over borrowing and taking on more debt than they can afford.

Okay, on to the new credit scoring changes.

Some providers like a firm have already started reporting to credit bureaus like Xperian and TransUnion.

Has there been any impact yet to reports or credit scores?

Not that I've seen and definitely not at scale.

This has been an issue with BNPL for a long time where a credit bureau or a BNPL provider will make some big announcement about reporting BNPL loans and nothing ever really comes of it.

A firm has actually been reporting some of its loan information to Experian for years.

So historically, it's a lot of chatter with few tangible results.

And that's because there hasn't been a widely used scoring model available that could process these types of loans.

That's changing now.

And what prompted FICO to include BNPL in its scoring?

I think FICO recognized this growing blind spot with BNPL and how their existing models just don't translate.

Let me give you an example.

Traditionally, if you open and close a bunch of new lines of credit in a short period of time, that's a bad thing for your credit.

It doesn't look good to do that.

It hurts your score.

But that's exactly how BNPL loans work.

They're short-term loans for small expenses, so you're opening and closing these loans constantly.

And in the world of BNPL, that's arguably a good thing.

It means you're successfully paying off the loan and getting approved for another.

But using the existing scoring models, that behavior is going to hurt you.

So FICO had to figure out how to make a new scoring model that accurately assesses BNPL usage, which is where these new FICO 10 scores come into play.

And are there any any upsides for consumers about their BNPL data being reported to credit bureaus?

Absolutely.

Your credit score, your credit history are some of the most important pieces of financial information about you.

It's how you get approved for a credit card, a mortgage, a car loan, a personal loan if you need to cover an emergency expense.

So if you're someone who uses BNPL regularly and you use it responsibly, meaning you make the payments on time, having that payment history reported to the bureaus is a good thing.

Ideally, you're going to have this shiny new record of responsible repayment behavior, which should help build your credit score over time and make it easier to get approved for different types of credit in the future.

That's especially important for BNPL users who tend to have lower credit scores to begin with.

Now, the NERVALAT survey showed that one in five Buy Now Pay Later users have paid late fees or interest after missing a payment over the last 12 months.

Now, how could late or missed payments hurt people's scores and ability to get credit?

I think it's safe to assume that missing a payment on a BNPL loan, like missing a payment on a traditional loan, will hurt your credit score, especially if it becomes a habit.

FICO places a heavy emphasis on payment history.

It's actually the most important thing that determines your score.

So most likely it'll be the same with these new scoring models.

And how soon could consumers see BNPL reporting on their credit reports?

That's the big question.

FICO says they're releasing the scoring models in the fall, but I think it may take some time for this to actually show up on credit reports.

So many players have to come together.

The BNPL providers have to be willing to report their loan data, which some have been pretty resistant to in the past.

And then the bureaus have to be willing to display that information to lenders.

It's a lot of moving parts.

But I do think there's some real urgency with trying to finally get these loans on the books, so that may help push it forward.

BNPLs are non-traditional loans, right?

How do they compare to more traditional ones?

Well, there's some key differences right from the jump, including in the application process.

A traditional lender, like your bank or credit union, is almost always going to do a hard credit pool when you apply for credit.

That sounds bad to a lot of people, but it can be a way of protecting you so you don't overborrow.

BNPL providers tend to be more lenient.

They may do a soft pool, but they'll still lend to borrowers with pretty low credit scores, and approval decisions are instantaneous, so it's not like you're waiting a few days to hear back.

With classic BNPL loans, so that's your paying for plan, you're typically not paying interest, so it's not costing you anything extra to break up your purchase.

A personal loan from your bank or credit union may charge rates up to 36%.

Some providers, like a firm or PayPal, also don't charge fees, which is different from traditional lenders too, who charge origination fees, late fees, return payment fees.

And then the repayment term is significantly shorter.

A paying for loan is six weeks versus a traditional loan, which may be more like two to seven years.

That being said, loan amounts are a lot higher for personal loans, so you need more time to pay them back.

So if you are going to buy now and pay later, what are some best practices for doing so?

Shop with a budget in mind, first of all, because it's easy to overspend with BNPL since you're not paying the full amount up front.

All of a sudden, a $200 purchase is only $50 a checkout.

So it seems like you can maybe go back and buy a couple more things.

It makes you feel like you have more financial flexibility than you probably do.

I'd also recommend setting up automatic payments for BNPL loans, though you'll want to keep an eye on your checking account to make sure you have plenty of funds available.

But this helps prevent late fees, which many BNPL providers charge.

I'd also avoid loan stacking, which is where you take out a ton of these loans at the same time, possibly from different providers.

Because the payments are due every two weeks and you've got multiple loans going on, it's just so hard to stay on top of it.

Think death by a thousand cuts, $20 here, $25 there.

Next thing you know, it's the first of the month and you're short on rent.

That makes sense.

The Nervalt survey had found that one in five users have carried multiple loans at the same time over a 12-month period.

Should users treat BNPL as a strategy to build credit?

If building credit is a big priority for you, I'd argue there are better ways to do that than BNPL, even with the new scoring models.

I'd go with a more well-established credit building product, like a credit builder loan or a starter credit card from your bank.

Those payments will be consistently reported to the three main credit bureaus using the older scoring models, so I just think it's a safer bet.

That being said, if BNPL becomes this additional form of credit building for you, I don't think there's anything wrong with that.

Now, before we let you go, I'm hoping you can give us status of BNPL oversight enforcement by the Consumer Financial Protection Bureau under the Trump administration.

So back in 2024, under the Biden administration, the CFPB issued an interpretive rule stating that BNPL should be treated the same as credit cards and that consumers should have the same legal protections.

Basically, that meant much stricter requirements for the BNPL companies.

Now they need to provide regular billing statements, issue timely refunds for returns, pause payments during an open dispute.

But this ruling has since been withdrawn by the CFPB under the new Trump administration and it's essentially dead in the water.

BNPL companies don't have to follow those requirements.

And what does that mean for buy now pay later borrowers?

It means that they need to be their own watchdog because there isn't a ton of oversight right now, at least at at the federal level.

So what that means practically, you want to avoid overspending, like we talked about, and late payments, but also you want to minimize BNPL for purchases where there's a good chance you'll need to make a return or file some type of dispute.

This tends to be where I hear the most frustration from readers.

Someone makes a return or has a complaint and the BNPL company isn't getting back to them and they're still having to make payments every two weeks and it's really frustrating.

And some companies are obviously better than others when it comes to customer service.

So it's important to do your research online.

But if you can avoid those types of scenarios as a general rule, that will go a long way in protecting you when you do use BNPL to pay for something.

All right.

Thanks for joining us today, Jackie.

Thanks, Ana.

And thank you, Ana.

Sure.

Thanks, Sean.

Elizabeth, are you a buy now paylater person?

I have stories on that.

I used to be.

I have thrown in the towel because that is a slow creep.

So I'm not anymore.

But yeah.

That is why I'm wary of them.

So understood.

Well, up next, we answer a listener's question about how to responsibly use an unexpected windfall.

But before we get into that, a reminder, listener, to send us your money questions.

Maybe you have a question about how you can budget for a large payment so you don't have to use Buy Now Pay Later, or you want to know the most responsible way to use it.

Either way, leave us a voicemail or text us on the Nerd Hotline at 901-730-6373.

Again, 901-730-N-E-R-D.

Of course, we love emails, so send us one at podcast at nerdwallet.com.

In a moment, this episode's Money Question.

Stay with us.

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We are back and answering your money questions to help you make smarter financial decisions.

This episode's question comes from Jared, who sent us an email.

Here it is, as read by our audio mixing pro, Nick Karissimi.

Hey, I'm a big fan of the show.

It's a regular listen for me on my work commute.

I'm a 26-year-old working in the environmental field.

An unfortunate reality of working in this field is that it can be financially troublesome.

I just inherited $124,000 and would like to make my grandparents proud with their money.

I have $20,000 in outstanding student loan debt, so I will be starting by paying that off.

I'm otherwise debt-free.

I'm renting an apartment with my partner and would like to set aside some money for a down payment on a house in hopefully three to five years.

Outside of that, I have a six-month emergency fund, about $8,000 in a federal RAW TSP retirement account, and I just opened a 457 retirement account through my state job, which is up to $75 monthly match.

I'm salaried at $45,072, hoping to get that closer to $60,000 by the end of the year.

Right now, I have the inheritance with my emergency fund in a high-yield savings, producing 3.6% APY.

I'm thinking it makes sense to take $50,000 from my future down payment and keep it there or in another HYS, purchase a CD or possibly open a high-yield checking account that I heard about at a local credit union, offering 5.5% on up to $25,000.

The other 50K I would like to invest.

Right now, I'm considering putting 25K into an IRA, potentially cranking up my 457 457 contribution and living on the savings to shift it, and opening a brokerage account with the other 25K using a Robo-Advisor.

Thank you, Jared.

To help us answer Jared's question on this episode of the podcast, we are joined by investing nerd Alana Benson.

Hey, Alana, welcome back to Smart Money.

Hi, guys.

Thanks for having me.

Great to have you on.

I want to start by talking about windfalls generally because they can be pretty sweet and sometimes they can totally transform your financial life.

Have either of you ever received a windfall?

And if so, what did you do with it?

I have not, but I have to say, I would probably do something similar to our listener if I did.

Spread it across a few different priorities and generally make a smart plan for it.

Yeah, and being like very responsible and struggling to use it for fun.

Yeah, we're going to get to that part of it because money is about having fun too sometimes.

Elizabeth, what about you?

I have not received a windfall and you guys should thank the heavens that I haven't because I wouldn't be here today if I did.

Okay.

All right.

It would all go toward fun.

Maybe kickstart that fire fund that you're working toward.

Look at you all in my business.

20-something-year-old me absolutely would be out having fun.

But this version of me, of course, I do something similar to Alana, but I'm definitely going to have a fun budget.

And they're going to be like, who is this girl?

Where did she get all this money from?

None of your business.

Yeah.

I actually have received a windfall if you guys want to hear about it.

Yeah, I do.

Yeah, I know you're nosy, Elizabeth.

So this was a few years back.

NerdWallet went public and I had a decent amount of stock saved up.

And so I sold a solid chunk of it.

And, you know, it wasn't $124,000, but it was enough money to help me make a lot of progress on some different financial goals all at the same time.

And so similar to Jared, I paid off some student loans.

I put money toward my higher interest student loans.

I put a big chunk in an investment account.

I put a bunch toward my savings to have an extra cushion there.

And then I did allocate 10% just for fun.

This is a piece of advice that my former co-host Liz Weston recommended because, again, money is meant to be enjoyed.

And sometimes, if you're overly restrictive with it and you're too disciplined, at least for me, I know I'm going to end up rebelling against myself and maybe overspending.

But I have still felt the dividends, if you will, of that windfall years later.

It's made me feel really secure financially.

And I've seen how my investments and my savings have grown over time.

And I can point a lot of my sense of security that I feel now back to that one windfall.

So it goes to show the power of having a big influx of cash like this.

Good to remember that money is like a tool for us to have great lives.

It's not this thing that we just have to acquire infinitely.

It's a

means to an end.

I think windfalls are a time to live by the adage of planning for tomorrow, but living for today because there is no guarantee of tomorrow.

I think that my situation was a little bit different than something like what Jared is going through, where I had a family member last year lose their spouse and they came into a decent amount of money from life insurance.

And I advised this family member to sit and wait and not be too rash with their money.

And they didn't really heed my advice.

And now, guess what?

$250,000 is gone.

Wow.

So that was painful to see happen, but everyone has to learn their lessons in their own way, I guess.

Beyond that, I think what Jared is doing, what I did was focusing on financial priorities here.

So if you have high interest debt, it's a good idea to pay that off.

Topping off your emergency fund is great.

Also investing for financial goals and things to not do.

Like I said, don't spend it all quickly.

Don't give it to people who come out of the woodwork.

Don't not have a plan for it.

Be thoughtful about what you're doing with this money because it's an amazing opportunity.

I'd certainly agree with that.

I think especially your situation, Sean, was a little bit different.

One, you work at NerdWallet and you were very well versed in the steps of what you should do for your financial goals, but that's not necessarily everyone.

And so if you come into a lot of money, you might be having to do a lot of self-education and figuring out how to do all this stuff.

And that takes time.

And also, if a windfall is coming from a place of grief, you know, if you've lost a loved one, it's really important to take time to grieve so that you can make those decisions with a clear head.

And that brings me to something else that Jared pointed out that I thought was really smart and thoughtful is that they want to make their grandparents proud.

So maybe Jared can consider what that might be.

I don't know what their grandparents valued.

Maybe it was travel.

Maybe it was investing for your future.

But setting aside some of the money that you have from this windfall just for that purpose, I think would bring a lot of satisfaction.

It would be a really lovely way to honor their memory too.

So what comes to mind for me, even though I haven't experienced a windfall, is I would love if I did to put a huge chunk into investing and watch that baby compound and grow.

So Alana, as you're the investing expert here, can you tell us a bit about how Jared could potentially invest this money or a portion of it?

I think he's got some really good ideas going forward.

I think it's great to look at your goals holistically.

And I always like to think, you know, those fountains that water like flows out of the top bucket and then it fills up the second bucket.

And then once that second bucket is full, it overflows into the third, like a garden feature.

So I always think of that in terms of your financial priority.

So the first one is, you know, saving an emergency fund.

So once you save that up, it can overflow into the next bucket.

Once you do that, you can pay down high interest debt and then go from there into things like putting money towards your 401k enough to get the match and all these things.

And so I think it's great the way that he's modeling this of, okay, I'm going to put this over here.

I'm going to put this over here.

There's a couple of little things I think we should chat about, but I think overall, I think he's got a good plan.

So, when it comes to timelines, can you detail how the time until you need the money can dictate where it should go?

Yeah, absolutely.

So, it's a really important thing.

If you're going to need the money in a shorter timeframe, say five years, you don't want to invest that money in the stock market.

And that's because the highs and lows, peaks and valleys, when you get that shorter timeframe, if you go to pull your money out and the market happens to be down, you're essentially locking in those losses.

So, you do have the possibility of losing a fair amount of the value of the money that you put in.

The stock market is for investments that are long-term, 10 years or more, preferably closer to like 20 or 30, because almost certainly you'll have quite a bit more than when you started because those peaks and valleys smooth out into a generally upward trending line over time.

So if you're going to do shorter timeframe, you know, if you're saving for a down payment on a house and you want to buy that house in under five years, it's a great idea to put money into a CD or even a high yield savings account because those rates are really, really high right now.

So you'll be getting some interest on that and you can pull that money out at any time and there's no risk to losing it in the market.

And it seems like that is about what Jared has in mind as well.

But let's talk about how else they want to invest because Jared has a pretty sophisticated strategy or potential strategy for how they want to put their money in these different buckets here.

They're considering breaking up investments across their IRA and a RoboAdvisor, which I am assuming is a brokerage account.

So can you talk about the pros and cons of each of these accounts and also just a quick explanation of what a Robo-Advisor is?

Because some folks may not be familiar with this option.

One of the things that we have to keep in mind is that these are actually two sort of separate categories of things.

So a Robo-Advisor is a company or it's brokerage essentially that is a computer algorithm that manages your money for you.

You just give give them money and they put your investments in and it's all automated and you don't have to do anything.

It's calibrated to your age, your risk tolerance, a lot of other personal factors.

So it's great if you don't want to worry about investing or deal with picking your investments.

It's awesome.

They do charge a small fee.

It's typically around 0.25% of your assets under management.

So however much money you give them, they take a percentage as a fee.

And the thing is with a robo-advisor, you can have an IRA with a robo-advisor.

The robo-advisor essentially is just how it's managed, whether you're managing it yourself or you're having a robo-advisor manage it for you.

An IRA is a type of investment account, as is a brokerage account.

Technically, an IRA is a type of brokerage account, but we just want to be really careful with the language that we use around these things.

We have a lot of people who think IRAs are investments themselves.

They put the money in and they don't buy investments.

And then 10 years they're saying, man, like, why haven't I made any money?

So yeah, a Robo-Advisor is great.

You can open an IRA or a Roth IRA through a RoboAdvisor, or you could open it up at a more traditional brokerage where you are buying your own investments and managing them yourself.

Okay.

And then one thing I also wanted to flag is that our listener, Jared, at the ripe young age of 26, wants to put $25,000 into an IRA, which is great.

They will definitely see that payover over time unless the market implodes or something.

But but jared should keep in mind that there are annual contribution limits you can only put in seven thousand dollars a year for those under 50

so for that twenty five thousand dollars jared just might need to space that out over a few years to actually put all of that in there in the meantime it might be wise to keep that amount in a high old savings account or if they want to invest everything all at once in a less tax advantage account then they could opt for something like a traditional taxable brokerage account which again could be a robo advisor account.

Yeah.

And I think it would be good to kind of weigh those options, right?

Do you want to park that money in a high-yield savings account so you just have it and then put it in annually when it opens up and you can contribute more to your IRA?

Or do you want to put in $7,000 this year and then take the rest of it and put it into a standard brokerage account?

And you can even do that math as to like, okay, I'd earn approximately this much interest over the next couple of years versus how much I would save on my taxes.

It gets a little nebulous, but I feel like Jared is up to the task.

Might be a good time to rope in a CPA to do some of this math for you.

Yeah, that's what I'd do.

Or if Jared is bored, they can use our compound interest calculator to look at the differences between interests with the different vehicles.

Alana, so all this talk about different accounts is making me think about fees because these different accounts do come with fees.

Things like expense ratios and also management fees should be taken into account.

So what should Jara be looking out for when it comes to fees?

And how much of an impact do fees really have on long-term growth?

Yeah, fees are really important.

If you are with a traditional financial advisor, you might be paying pretty high fees.

So what I was talking about before with the robo-advisor, that's a management fee.

That's what you're paying them to do the work of managing and looking after your investments so you don't have to.

And as I said, 0.25% is a pretty good spot for that.

That's what most robo-advisors charge.

There are some that charge no management fee.

So you can take a look at some of our Roundups and see which ones have no fees because those are really great.

It allows you to get management for free.

One other fee is, as you mentioned, expense ratios.

So for every fund, this is a basket of investments, whether that's stocks or bonds or what have you.

These funds are what most people will be investing in largely.

A lot of people, you probably shouldn't be buying individual stocks for your your entire portfolio.

So, funds, even if they're passively managed, have what's called an expense ratio where the fund is charging this to manage the fund.

So, even if you're at a robo-advisor, your robo-advisor is investing in funds.

So, those funds still charge expense ratios, versus if you're investing on your own and you're buying a fund, you also have to pay the expense ratio.

So, you kind of have to pay them no matter what, but you can find funds that have very, very low expense ratios, like 0.10%

is a pretty good benchmark.

Sometimes they can get lower.

There's some brokers that offer some funds with no expense ratios, but you do end up paying those every year and they're not going to be listed on a statement.

So if you get all your info about, you know, how much interest you've made and the fees you've paid, you should really pay attention to what it says up front about the expense ratios because it's not going to be in that paperwork.

If folks want to see how fees can make an impact on the amount that you earn in your investments over time, we do have an expense ratio calculator at NerdWallet.

I recommend you check that out.

It's actually really informative.

Just Google NerdWallet expense ratio calculator and play around with it.

We've discussed IRAs, 401ks,

CDs, Alana.

Are there any other accounts that you can think of that the listener may consider parking money in?

Very much depends on what they want to do with their money.

I think they've been very, very thorough.

One of the things that if they're thinking of having a family eventually, they can look into 529 college plans because as we know with compound interest, the earlier you start saving, the less you actually have to save, the less you actually have to invest in this case.

So if they are thinking about kids and thinking about college for those kids, that is something that they could also consider.

But I do want to touch on the fact that this listener has some specialty accounts that they have access to because they are a state employee.

And so I like to highlight just the fact that everyone's financial situation is different.

Everyone has access to different things.

And so, you know, maybe you work for a nonprofit, maybe you work for the government.

And there are always going to be different inputs to your life that we may not necessarily be able to speak on for every individual.

So it's so important to understand what you have access to, what programs or accounts or different things that may be able to get you a discount or a better savings rate.

With those five to nine college plans, there's a different one for pretty much every state and they have different incentives.

So it's always good to look into what you specifically have access to.

One quick note on 529s, they are really helpful tools for college savings and you can invest in them just about as soon as you have your child's social security number.

So really handy there.

So if someone is debating a few different investment options that might seem relatively similar, how can someone decide which one might actually be best for them?

So in addition to their own personal situation and what they have access to, it's really great to consider future tax implications.

So, whether that's investing in a Roth versus a traditional IRA with the different tax breakdowns of those, if they have access to a 401k, if they get match percentage, if they don't get a match percentage, that's something that is really important to consider.

Management is also a really important thing.

Not everyone wants to be looking at stocks all the time and trading and doing that.

For me, I'm a very lazy and boring investor.

I want to to basically forget about it and not even have to look at it until I'm in retirement.

So do you want to manage this yourself or do you want a little bit of help?

And is it worth it to you to pay some extra money to just not have to consider it?

That's another consideration.

And like you said, your comfort level and fun.

Are you going to treat yourself to something?

Are you going to balance that with your responsibilities and financial burdens and things like that?

And, you know, it might be nice to go on vacation.

I think so.

I'd say go on a nice vacation, maybe buy some nice clothes for said vacation and have nice meals on that vacation.

Don't want to make any assumptions about Jared's grandma or the person who gave him the windfall, but I'm sure they would love them to enjoy themselves a little with the money too.

Absolutely.

Well, Alana, thank you for coming on and sharing your thoughts with us today.

Thank you guys for having me.

That is all we have for this episode.

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