BNPL credit facility used without caution can lead to a debt trap

Understand all the attendant costs of this facility; delayed repayment will hit your credit score

Buy now pay later (BNPL) has been gaining traction in India. According to a Kotak Institutional Equities report, BNPL providers extended over 4 million lines of credit to customers in the fourth quarter of calendar year 2021. Customers using this relatively new form of credit must, however, exercise caution, especially if they are themselves new to credit.

Easy access to credit

One reason for BNPL’s growing popularity is easy access. Onboarding is digital and usually seamless, with very few documents asked for. Getting a personal loan or credit card requires more documents and is usually more time consuming, especially in the case of new customers.

BNPL can be especially useful for new-to-credit customers. “India has 550 million PAN card holders. A number of them are self-employed, or employed in informal or unorganised sectors. More than 10 million customers enter the workforce every year. The majority of them don’t have a credit score and find it hard to access credit from banks and other traditional credit providers. They depend on friends, family or loan sharks for credit,” says Abhineet Sawa, co-founder of Snapmint. He adds that BNPL is targeted at this segment. It allows them to buy products that they aspire to, but which are currently beyond their budget.

According to Arun Ramamurthy, director, Andromeda Sales and Distribution, and an expert on digital lending: “Credit card penetration in India is quite low in India. BNPL has the potential to get a lot of people, who are currently outside the formal credit system, in, and thus expand credit penetration.”

Many people who have access to credit cards and internet banking also use BNPL for its convenience.

Get informed about interest rates, other charges

BNPL comes with a variety of costs that users need to be aware of before they begin using this form of credit. No interest is charged on the initial few days of credit, usually up to a fortnight. “If this credit facility is used for a longer period, say, between two months and up to two years, then the annual interest charge could range from zero to 36 per cent,” says Deepti George, executive director and head of strategy, Dvara Research, which recently conducted an in-depth study on BNPL.

If the customer defaults on payment of an EMI, there are charges. “Some players give the charges as a percentage of the outstanding amount. Others provide a charge sheet, where, depending on the amount due (stated in slabs), a flat charge in rupee terms is mentioned. This could go up to 50 per cent per month (simple interest),” says George.

Undisclosed processing fee

Some players mention the processing fee as a percentage of the loan or as a flat amount. They charge it after the application is approved, and in some cases, before money has been disbursed.

“Some players say in their terms and conditions that the customer could be charged an unspecified and non-refundable fee for processing the application. This fee would have to be paid even if the customer’s loan is cancelled. While this information is available on their websites, it is not readily accessible during the on-boarding process. The non-disclosure of fees can make it difficult for customers to gauge the costs of borrowing from these providers,” says George.

Credit line cancelled

In the case of one researcher at Dvara Research, who had applied for the BNPL credit line as part of the study, the line was cancelled after less than a month of usage and she was asked to immediately repay the outstanding amount. No reason was provided for the cancellation. Payment was demanded immediately.

“In this case, the amount was small. But if a customer has borrowed a large sum, it could land her in trouble,” says George.

In their terms and conditions, BNPL players have a clause that gives them the right to recall the credit line at any point in the tenure.

Ramamurthy says: “Most lenders, even banks and NBFCs, which give out personal loans and other forms of credit, have this clause, though it is seldom exercised.”

Nonetheless, this is a risk all those applying for BNPL must bear in mind.

No affordability check, high limits

Most BNPL providers may not ask for your bank statement or Income-Tax returns for the purpose of income assessment. Providers may verify the credit score, but these scores may not paint a true picture of repayment capability, especially for people who are new to using credit. This carries the risk of borrowers facing difficulties in repayment after being given disproportionate amounts through the credit line. For instance, even if a customer’s plan was to make a purchase of Rs. 5,000, she could be sanctioned a limit of Rs 2 lakh or 4 lakh.

“Credit cards, too, have a limit that is much higher than the customer’s average transaction size,” points out Ramamurthy.  

However, banks do evaluate income before issuing cards.

What should you do?  

Customers using this credit facility must understand all the charges instead of rushing in to borrow because credit is easily available. “Understand fully the interest cost on longer-duration credit, penalty in case of a default, and processing charges,” says Arnav Pandya, founder, Moneyeduschool.

Information on charges is likely to be available in the terms and conditions document.

Avoid using this instrument for longer duration credit. “Repay within the interest-free period. If you can’t, and have a card, use it and convert the loan into EMIs,” says Pandya.

Depending on your credit score, some players could allow you to convert your card outstanding into EMIs at a rate as low as 8-10 per cent. The more typical range tends to be between 15 and 25 per cent.  

Who’s the final lender

Some BNPLs have a bank or NBFC at the back end. Find out who is the entity providing the funding. These back-end entities are likely to be regulated by the Reserve Bank of India (RBI), so you can complain to them or the ombudsman in case of a problem.

One basic point, which many new-to-credit borrowers forget is that BNPL is ultimately a loan facility.  “If you default on payment, your credit score will be affected,” says Pandya.

As mentioned above, the sanctioned limit could be higher than the purchase price of the goods bought via BNPL. “People who use this credit facility excessively or carelessly could find themselves in a debt trap,” says Pandya.

RBI restriction on loading PPIs with credit lines: What it means for customers

· A BNPL customer could be provided with a wallet

· The credit limit sanctioned for the customer was loaded on the wallet

· Usually, a customer transfers money from her own bank account into the wallet, i.e., the money in a wallet is her own

· Once a credit line gets loaded on the wallet, she begins to use borrowed money

· Functionally, the wallet becomes similar to a credit card

· However, there are restrictions on who can carry out credit card business (RBI’s permission is required)

· After the regulator’s directive, BNPL players will be able to provide credit at the time of check-out on e-commerce sites, but they won’t be able to load wallets with credit facility