Stop Assuming Payment Plans Are a Debt Trap and Start Doing the Math

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19:27Sean Pyles:Today's question comes from Emma by email, and it's about whether credit card payment plans are a go or a no. Hello, I love your podcast, and I have a question about credit card pay plans. I'm a graduate student, and I just bought a ton of furnishings for my new apartment, as well as paid for some hefty vet bills and expensive textbooks. I have enough money to cover it, but it would be cutting into my savings more than I'd like. Bank of America recently rolled out something where you can take eligible purchases and make pay plans through them after the thought. Any purchase above$100 is eligible, and you can pay it off in three or six months with a monthly fee of around$5 or less.

20:04Sean Pyles:The APR on my cards are about 17 % on one and about 27 % on the other. I'm wondering when pay plans are worth it, specifically ones through your own bank slash credit card company. I've always been wary of layaway plans and the such, but this feels different than just through my bank. I know y 'all have done a few buy now, pay later episodes, but I'm wondering if this differs at all and how it differs. Does it impact your credit? When is it beneficial and who is it beneficial for? Is it silly to do this payment plan after purchasing and bypassing available layaway slash buy now, pay later options at the time of purchase?

20:40Sean Pyles:Does it impact my credit card rewards? Would it be worth it for my credit card with higher APR that also has a higher credit limit? Thanks, Emma.

20:50Elizabeth Ayoola:To help us answer this question, we are joined by no stranger to the pod, NerdWallet spokesperson and credit card writer, Sarah Rathner. Hey, Sarah, welcome back. Hi, thanks for having me. I'm excited to answer all of Emma's questions. So when I log into my credit card account, I hate doing that, but when I do have a balance, Like Emma, I have seen the offer to split my purchase into several payments over time. And honestly, I've never been curious enough to investigate so that I could answer Emma's questions myself because I try to pay off my balance in full. So tell us what are credit card payment plans and how do they work?

21:24I've seen this, too. And those of you listening might have seen these options when you look at your own recent charges, because a lot of different major credit card issuers offer the option to take a recent purchase that's a minimum amount, say$75 or$100 or more, and apply a payment plan or installment plan to that purchase. So instead of adding it to your usual credit card bill, it now becomes an installment plan and you can pay it off in four payments. You could pay it off over three months, six months, sometimes even longer, depending on the plan.

21:56Sean Pyles:And it seems like Emma is looking for the most cost-effective way to pay off their balance from large purchases. And they kind of have two options, gradually pay off the balance on their credit card that have, again, that 17 and 27 % APRs, which are pretty high, or using a credit card payment plan, which they mentioned has a monthly fee of around$5 or less. So Sarah, what do you think about how people can determine whether it's more cost-effective to use a credit card payment plan or just pay off the balance on your credit card over time using your existing APR? It really comes down to the math, because if you're going to carry a balance for month to month on your credit card, depending on your card's interest rate, that could grow pretty quickly.

22:38And Emma mentioned a credit card with an APR of 27%, which is above the average credit card interest rate. That's pretty high. Here's an actual example with real numbers. If you put a thousand dollar charge on a card with 22 % interest rate, let's say $5 ,000 bought a new couch. And then you paid it off over six months. Then you spend$65 on interest. Emma said the plan that they were offered charged a monthly fee of$5. So over six months, if the plan allowed you to pay it off over that time frame, you would end up spending$30 in fees instead of$65 in interest. So that's why it's good to compare the overall cost of different forms of borrowing because the cheapest option might actually surprise you.

23:23We gravitate toward what's familiar, but a newer option or a different option might actually be less expensive. You do want to just be mindful, though, that the risk of carrying any sort of credit card balance, including these installment plans, because this is a form of borrowing, especially if you're going to continue adding charges to the card because spending doesn't stop just because you have debt, that's where you just run the risk of your balance growing and growing and growing and pretty quickly it's unsustainable for you to be able to pay it down. And so you just want to be mindful before taking on any sort of borrowing instead of paying for purchases outright.

23:58How is this going to affect your financial decision making over the next couple of months?

24:02Sean Pyles:Yeah, there are a lot of behavioral risks around credit cards and just continuing to add to your balance when you think you have a plan to paying it off is one of those big risks. You want to be very strategic about actually minimizing your balance and getting it to zero at the end of that payment period. But I do kind of like the strategy of using it as almost an oops, I charge too much of my credit card, let me pay it off in a less expensive way. Because as you illustrated, Sarah, it would cost less than half the amount in interest if you went with the payment plan option versus just paying it off via the APR.

24:31Yeah, because typically these payment plans either charge a fixed fee, it's a small percentage of the amount that you borrow, or they charge a lower APR than your credit card typically charges. And so that's why it's important to do the math, because it could end up being the less expensive way to borrow. You just want to be able to make all those payments on time.

24:51Sean Pyles:I think it might be smart for someone to consider if they're going to be doing something like this, maybe what's the buy now pay later cost? What is the credit card payment plan cost? And what would be actual credit card APR cost of doing this if you're going to go one of these three routes? I want to talk about other balances that people might have. So how does enrolling in a purchase payment plan affect other balances that Emma might owe? Does any other existing balance keep accruing interest in the background? I imagine the case would be yes. It would, yes. So the monthly payments for one of these installment payment plans get added to the minimum required payment on your credit card each month.

25:25So whenever you receive your credit card statement, it says this is what you actually owe. This is your current balance. But you have to at least pay this smaller number. So that smaller number is going to grow because it's going to include what you owe for the payment plan. So until you pay that payment plan off, your minimum balance due is just going to be higher. Now, other balances above and beyond that can still accrue interest, but the way to avoid paying interest is to pay those charges off in full on time when your credit card payment is due.

25:57Elizabeth Ayoola:I think it's just a reminder that when you've overspent or when you've made a large purchase, you just have to remember no matter what kind of payment plan you use to try to keep your spending low until you clear that balance and not maybe keep spending at the same pace that you are. As you're explaining these payment plans, Sarah, they sound a lot to me like buy now, pay later plans. And I think many people have heard of those. But for those who haven't, it allows you to split your payments over six weeks, interest free. But many of the plans sometimes come with fees. Now, what is the difference between the plans that we're talking about that can come from your bank or your credit card providers and then a buy now, pay later plan?

26:32I mean, they're basically all the same thing. They're just provided by different companies. So sometimes they're payoff in six weeks. They might also provide longer payoff timeframes, six months, a year. It just kind of depends on what you qualify for. And then you might be presented with several different payment time frame options and interest rate options and fee options. And then it's up to you to decide if any of them are the most appealing to you. And if so, then you enter into the plan. And so the main difference is with a what I call like a third party buy now, pay later plan. You might have heard of some of these companies like Klarna and Afterpay and Affirm.

27:07These are often offered to you at checkout. So when you make a purchase, that's your decision point. Do I want to enter into a payment plan with this provider when I make the purchase? And oftentimes these providers partner with retailers, so different retailers offer different companies as providers for these plans. The credit card option allows you to apply this retroactively to a recent purchase. So you can make the purchase as you normally would and then think about it for a little bit and then decide whether or not you want to split that purchase into installments.

27:41Sean Pyles:I'm not a big fan of Buy Now, Pay Later. It has gotten a reputation for being a debt trap, especially for younger consumers. And it seems like Emma shares those sentiments because they describe themselves as wary of layaway and buy now, pay later. But they say that the credit card payment plan feels different because it's through their bank. So do credit card payment plans carry the same risk as buy now, pay later in terms of being a potential debt trap or is it different? Nope, they are all equally debt traps. Great. That's what I thought. There's no nicer way I can put that. Listen, the risk with any buy now, pay later plan, regardless of who the provider is, is that when you miss payments, if that happens and it does happen, that's when they can hurt your credit score.

28:24So you like I said before, you want to think of this as a form of borrowing. You want to be a little afraid of it because fear is that incredible motivator to make those payments on time because you're afraid of the consequences. And so I think if you're going to enter into one of these plans, don't do it casually. They are so casually offered. You could buy like shampoo and have it be on buy now, pay later or a burrito or whatever. No, because you can doesn't mean you should. But Emma's thinking about this strategically. Emma has made some very large purchases recently. I've experienced the four digit vet bill before myself.

29:02And so they are thinking about how they can spread the burden of these expensive payments over time so they don't have to necessarily drain their savings. And that's a really thoughtful way to go about using Buy Now Pay Later.

29:15Elizabeth Ayoola:Well, I've been in debt before and I can tell you right now I'm scared of debt. It's like a big ugly monster that comes and just eats up your paycheck every couple of weeks. I personally think being able to split purchases into monthly payments can make it easier to justify spending money that you, quite frankly, don't have. Especially when you're looking at the installment amounts versus the overall cost of whatever you're buying. So, Sarah, how do you view this approach of splitting up payments? Are you team debt trap or team strategic payment strategy? I urge anybody considering these plans to think about how much is this going to cost you above and beyond the price of the original purchase?

29:52So what sorts of fees or interest are you going to incur? So when these plans give you the final cost, hey, if you pay this out over six months or six payments or whatever, here's what you're going to pay. And they give you this big number. OK, how much bigger is that number compared to what you were going to buy in the first place? If you were going to make$150 purchase, but then it's going to cost an extra$12 in fees, OK, that purchase just cost you$12 more to go through buy now, pay later. That's just something to think about because if you do this a few times a year, over time it begins to add up.

30:27And you might not be doing this for a$150 purchase. You might be doing this for a$3 ,000 purchase, in which case a fee that's a fixed percentage of that$3 ,000 is going to be that much higher. And so you just want to be mindful of the overall cost of adding these plans into your life because you are paying more for the ability to pay more slowly. And if you're okay with that and you see the number and you can live with it, that's great. But if you're not thinking about that number when you enter into these plans, you're simply thinking about, oh, well, I only need to pay 25 % of this now, so I'm just going to do it.

31:02You really want to think about how much more this can cost you over time.

31:05Sean Pyles:It seems like the answer here is a big old, it depends, and it depends on the numbers. You have to do the math and think about what you feel comfortable paying because some people just don't want to pay any interest or fees, in which case maybe none of these options are great. We could talk about zero APR credit cards, but that's a whole nother episode. We do have a list of zero interest credit cards, and we'll have a link to that in the show notes. So check that out if you want to learn more. I want to focus a little more on the credit card payment plans and some pros and cons. So starting with some of the pros, Sarah, what do you think stands out here?

31:36The big pro here is convenience because you already have this credit card. There is no need to apply for anything else again to get access to these installment plans. It's not like applying for a personal loan separately. There's no hard credit inquiry. You opt into seeing what potential offers could be on the app you already use to manage your credit card. You see what they are. You either like them or you don't and you move on with your day. And so it's very seamless, which is great. It's also part of the danger because, you know, whenever you make spending easier and you remove friction, it makes it easier to spend more.

32:11And so friction can be a good thing, but it also can be a bad thing.

32:15Elizabeth Ayoola:Friction can be a great thing because sometimes when I see it pop up, when I'm buying groceries or whatever else, it's like, well, do I really need to split this in four? Just pay the whole thing right now. And I think it can be a psychological thing as well, because like Emma, sometimes you don't want to see that large chunk of money just leave your account all at once. Speaking of some pros, I heard from the grapevine that some providers allow you to continue earning rewards on your purchases while you use the plan. And no, people, I'm not saying use the plan and go crazy to get rewards. That sounds convenient, like you said, Sarah, but it also makes me think about how carrying a balance and paying interest on it can wipe out the value of those rewards.

32:52Elizabeth Ayoola:What are your thoughts? Huge benefit to a credit card buy now, pay later plan is that you would earn rewards on the purchase the same rate as you would if you put the purchase on your overall credit card balance and then paid it off at the end of the month. So if you enter into an installment plan because you bought a refrigerator and they cost like two grand and then you pay it off over time, you're still earning points on that$2 ,000 purchase, which is great. Asterisk. Obviously, if you get into credit card debt, interest rates being as high as they are, the amount of money you're spending on interest can wipe out the value of any rewards you earn on your card, sometimes in as little as just a few months, depending on your balance, your interest rate.

33:34So if you are potentially taking on debt, if you are not sure you're able to make all the payments on your installment plan on time, if you're carrying a balance otherwise on your credit card, this is not the time to chase rewards.

33:48Sean Pyles:Let's talk about some of the cons of using one of these plans besides potentially paying fees or, you know, getting into a debt trap here. What stands out to you? Yeah, the big one is if you miss any payments because then you might be subject to extra fees. your account could even eventually go into default, and that's going to affect your credit score. So if you want to enter into these plans, do so strategically, knowing that you have the money to make every payment on time until you pay off the purchase in full.

34:17Elizabeth Ayoola:Sarah, I'm sure every provider is different, but can you give some eligibility requirements to use credit card plans? I was doing some poke nosing, and I have the Chase Sapphire Reserve card, and I see that they have a My Chase plan, aka Buy Now, Pay Later plan, but only purchases made less than 90 days ago and that haven't been paid for on my regular card bill would be eligible. It really does depend on the provider. So American Express, for example, limits you to purchases that appear on your most recent billing statement or purchases that recently posted to your account. And Citi also has the same limit as American Express.

34:52And like I said earlier, an eligible purchase has to be a certain minimum amount, like$75 or$100 or more. Okay.

35:00Sean Pyles:I want to talk about credit here, too. Emma asked whether these plans impact their credit. So how would one of these plans potentially affect, maybe help or hurt Emma's credit? I mentioned earlier, if you miss a payment, it can hurt your credit. Can buy now, pay later help you build credit? Not yet. Not really. Great. Just downsides here. Two asterisks. I don't know. I'm going to have multiple footnotes to this conversation. It's certainly something that is being paid more attention to by like, you know, credit reporting agencies and companies that have scoring algorithms that take information and create a credit score.

35:36It has become so popular with consumers that it wouldn't surprise me more and more over the years to see this become more of a thing that could potentially help you build credit if you're responsible with it. But right now, it's not going to affect your credit score unless you miss a payment. So it can hurt you, but it's not going to help you.

35:51Sean Pyles:I really want to underline that because that is a little bananas to me. You're not getting credit for on-time payments, which is a huge factor in your credit score and your credit history. But you will be dinged if you don't make the payment on time. There's certainly an awakening to the fact that people can be responsible users of credit without being traditional users of credit. And so other payments like rent, utilities, things like that are beginning to be factored into and paid. You know, they're being paid attention to as a way to prove that somebody is creditworthy, which I think is awesome and way more inclusive.

36:25Not everybody can get a credit card. Not everybody wants to have a credit card. Not everybody has student loans. So showing the other ways that a person can be a responsible borrower by proving that they are capable of making on-time payments for a variety of different kinds of monthly expenses on time is awesome.

36:44Elizabeth Ayoola:Well, the social justice girly in me is happy that you guys pointed that out. I love the inclusivity cliff note that you left there. But I am going to play a little devil's advocate here, Sarah. I heard last fall, we did mention it on the show, that some lenders were going to start reporting buy now, pay later information to credit bureaus. Is that not a thing anymore? And if it is, doesn't that mean that positive payment history could positively impact one score? It's definitely still a thing, but it's not as simple as starting on this date, buy now, pay later is going to be reflected in your credit score.

37:15The end. FICO has two scoring models. They have many, but they have two newer ones. One is called FICO score 10 BNPL for buy now, pay later. Another one is called FICO score 10T BNPL. These are designed to incorporate buy now, pay later plans that are reported to credit bureaus and will appear on credit reports. That's the good news. The not so awesome news is that lenders choose which scoring models they use when evaluating applications for loans and credit cards. And if they don't use FICO 10 or 10T, which many don't for the time being, buy now, pay later simply isn't factored in. And as a consumer, you cannot choose which scoring model a lender uses.

37:57But different scoring models are designed for different types of borrowing. The scoring model used for mortgage applications is different from the one used for credit card applications, for example. And it is administratively complicated and expensive for a lender to change the scoring model they use. So even though new scoring models come to the market, it doesn't necessarily mean they're going to be widely adopted anytime soon. How long will it be until a credit card lender uses them exclusively? I don't know.

38:23Sean Pyles:We talk a lot on Smart Money about paying off credit cards in full every month, but we all know that's not realistic for a lot of people. So let's talk about some other ways to pay off large balances over time and lower fees. I did mention zero APR credit cards earlier and, you know, of course, official quote unquote buy now pay later programs like Klarna that we also mentioned before. How do you think these all factor into the decisions that Emma could be making? There are lots of different options out there for planned purchases, things that are not unexpected emergency expenses. You have more options because you're not acting out of desperation.

38:56If you know you want to replace your dishwasher in the next month, you have time to shop around, see what a probable price is, and then see what your borrowing options might be if you need to borrow money to make this purchase. But if your refrigerator dies and you have to buy a new one immediately or your dog is sick or your car needs new tires because you ran over a nail or something, then obviously you're making this decision with a lot higher pressure. And so you might not necessarily make the most optimal choice because you just don't have that many options. And so that's just something to think about.

39:28So if you have the luxury of a little bit of time, you can look into buy now, pay later, see what the fees are or the interest. You can look into credit cards that offer no interest promotions. Typically, that's 12 months or longer to pay down a balance at 0 % APR. That can save you a lot of money. You just want to be aware of the fact that once that no interest promotion on those credit cards ends, the APR returns to its standard level. So if you haven't paid your balance off in full, you still have some debt left on the card, you're going to begin owing interest on that.

39:59Sean Pyles:I think the situation you mentioned where if you run over a nail with your car and you need a new tire immediately, you have some sort of emergency expense that you don't want to just charge on your card. I think that is really where the credit card payment plans shine as a differentiator because you can use them retroactively. And that is different than something like taking out a zero APR credit card or using Klarna, which you might not have an option to use when you're at checkout getting your new tire. So I think that is kind of a cool feature to this and makes it a little bit more viable than other options in some ways.

40:30And again, with the third-party providers, since many of them partner with retailers, you might not be offered that as an option at checkout. If you're dealing with like a small business, maybe a small business, like a smaller mechanic, an independent veterinarian's office, things like that. They might offer some things, but not others. I know a lot of veterinarians offer a care credit, for example, which is often used for financing medical expenses specifically. But I mean, the mechanic that I go to is like a small independent business and they charge 3 % fees on credit card purchases, for example.

40:58So I might be in a situation where I'm like, well, I don't think I want to use credit because I want to pay a 3 % fee. And then that eliminates the option of financing that purchase later through a credit card buy now pay later plan. So that's another thing to factor into. Are you taking your car to a national chain or are you taking your car to an independent mechanic?

41:16Elizabeth Ayoola:Speaking of mechanics, guys, I have an on the spot quiz for you all. I went to get my car serviced. Boo. And I thought I just needed an oil change. And they're like, well, actually, you have X amount of miles. So you need a transmission flush. And you also need to change your brake fluid. Can we guess how much that's going to cost me?

41:38Sean Pyles:$2 ,500.

41:39Elizabeth Ayoola:Oh, no. That's terrible. $533. Still money I don't want to pay. A, could pull in my emergency fund. No, I do not have a sinking fund for my car, Sean. B, could use a credit card payment plan. And there is no C because there ain't no Qarna. So what would you guys do? I would pay it out of my savings.

42:01Sean Pyles:I'd try to use my credit card to get points if there isn't a 3 % fee like Sarah mentioned before. And then, yeah, pay out of savings because I do have my car fund in my savings bucket strategy. So I'm covered there.

42:13Elizabeth Ayoola:Yes, you may convince me to get a sinking fund for my car. But actually, I really like C, Sean. I really like charging to get my rewards and then just paying it out of my savings. Well, Sarah, thank you for coming on to answer this question and also answering my pop quiz question. I know I put you on the spot there.

42:29Sean Pyles:No, thanks for having me. And that's all we've got. Remember that we're here to answer your money questions, so send them our way. You can hit us up on the Nerd Hotline by leaving us a voicemail or texting us at 901-730-6373. It's 901-730-NERD. You can also email us at podcast at nerdrollet.com.

42:47Elizabeth Ayoola:And before we head out, I want to remind you all that we can look at your budget during one of our budget rehab episodes. If you need help managing your money or planning for a big expense, we can help you do that live. So just send us an email or fill out the budget rehab form, which we will include in the show description. Until then, join us next time to hear about transitioning to joint accounts and also shopping for banking. Follow Smart Money on your favorite podcast app. That includes Spotify, Apple Podcasts, and iHeartRadio to automatically download new episodes.

43:18Sean Pyles:And here's our brief disclaimer. We are not your financial or investment advisors. This nerdy info is provided for general educational and entertainment purposes and may not apply to your specific circumstances.

43:28Elizabeth Ayoola:This episode was produced by Tess Vigland, Hillary Georgie helped with editing, Eve Krogman edits our audio and our video, and a big thank you to NerdWallet's editors for their help.

43:37Sean Pyles:And with that said, until next time, turn to the nerds.

44:07for three months 90 for six months or 180 for 12 months plan required 15 per month equivalent taxes and fees extra initial plan term only greater than 50 gigabytes may slow when network is busy see terms