With buy now/pay later carving out its place as a lasting consumer credit product, nonbank lenders have been looking for ways to improve credit decisions.
Affirm has taken the first steps in reporting Pay-in-4 loans to credit bureaus. For banks and other lenders preparing for the day when Pay in 4 appears on credit reports, updating their own credit underwriting models will surely be a heavy lift.
On April 1, Affirm began reporting all its pay-over-time loans, including Pay in 4, to Experian. Affirm previously reported its monthly installments of its longer-term loans to Experian. And while the Pay-in-4 loans will be visible to consumers viewing their own credit reports, those new loans will not be factored into consumers' traditional credit scores and lenders won't have visibility to them — yet.
"Affirm operates on the principles of transparency and putting consumers first, which is why we have been actively engaged with Experian and across our industry to build upon our credit reporting practices," said Libor Michalek, president at Affirm, in a statement. "Having all loans reflected in a consumer's financial profile will help protect and empower borrowers."
The move marks a key step in getting Pay in 4 loans visible on consumers' credit reports, a gap that lenders have for years lamented due to a lack of transparency in consumers' debt obligations, which makes it difficult to properly underwrite other credit, such as an auto loan.
"Buy now/pay later is a practice. It's a habit," Bruce Newmark, president of consultancy firm Fimanco, told American Banker. "If you're somebody predisposed to buy things that you don't have cash for, and you either don't have a credit card or choose not to use a credit card, but are willing to use buy now/pay later, you're probably going to keep doing so."
But getting BNPL loans — especially Pay in 4 — reported to the credit reporting agencies and integrated into consumers' credit scores is no easy task, and requires a confluence of wider industry participation, exhaustive testing and changes to standard credit models.
Hungry for more data
First, more BNPL providers need to provide data to the credit bureaus before that data can be fed to credit scoring companies such as FICO and Vantage Score, Liz Pagel, senior vice president and global head of alternative credit data solutions at TransUnion, told American Banker. TransUnion has been working since 2019 to find a way to get BNPL loans included on consumers' credit reports, she said.
"We can't just have [one BNPL provider's] loans," Pagel said. "We can't expose that data to other lenders, because it'll be obvious [who that lender is]. We need critical mass, probably three or four lenders reporting all together, so the data is all mixed up and you can't target one lender. That's what we're waiting for."
But there's no regulation that requires BNPL lenders to furnish that data, meaning that the credit reporting agencies need to convince them one by one that reporting the data is in their best interest and their customers' best interest.
"This could be the biggest financial inclusion opportunity in generations," Pagel said.
Klarna began reporting some term loan data — such as application of a term loan, consummation of a term loan, on-time payments, overdue payments and defaults — to TransUnion on Nov. 1, 2024, but does not report its Pay in 4 payments to the CRA.
Klarna declined to comment for this article but directed American Banker to a May 13, 2024, blog post titled, "Why Klarna does not report BNPL payments to US credit bureaus."
"The credit models used today were built decades ago and calculate data based on monthly payments, long-term loans, and open lines of credit. But BNPL does not fit into these categories. BNPL has a bi-weekly payment cycle, is a short-term (six-week) product, and since each transaction is underwritten — unlike a credit card — it is not an open line of credit," according to the blog post.
"Logic would dictate that reporting positive repayment rates — like the 96% of Klarna BNPL users that pay on time — would improve a consumer's credit score, but the large credit bureaus continue to use outdated FICO and Vantage models that do not properly account for BNPL data," the post reads. "In fact, if on-time BNPL payments were factored into credit scoring today, consumers could see a significant drop in their credit score."
Afterpay and Zip Co. did not respond to requests for comment, but the Financial Technology Association, which counts Block, Afterpay's parent company, Zip and PayPal — who also offers Pay-in-4 loans — as members, said that it has actively engaged the credit bureaus about how to properly include BNPL loans as individual trade lines.
"We do think that somebody paying on time regularly … should be reflected positively," Penny Lee, president and CEO of the Financial Technology Association, told American Banker. "The Bureaus to date have not been able to do those individual trade lines, and so there are concerns about taking aggregate data and whether or not that is an accurate reflection of it. What we don't want is for this reporting, this data, to be reflected negatively in an unfair [manner]."
For BNPL providers, furnishing that information to the CRAs is no easy task, TransUnion's Pagel said. "They have to build up the operations to handle disputes. They have to build up the ability to fill in
Deciding how to ingest that data
For the credit bureaus, incorporating new data is also difficult.
"The current constructs of the credit report haven't had a new product in decades," Pagel said. "We've got credit cards, we've got personal loans, we've got mortgages, auto loans — all of those, like well-understood types of credit have been incorporated in this ecosystem for decades."
Pay-in-4 loans pose different challenges to the CRAs. One, they are short duration, and two, consumer payment behavior is different.
"The frequency problem is actually the biggest issue," Pagel said. "If you put your Klarna, Affirm or Afterpay loans on credit reports, and somebody uses 12 per year — which is pretty reasonable behavior for somebody using buy now/pay later — and you call that installment loan, all of the scores that we have would say that's a huge risk. Somebody taking out 12 installment loans a year is in big trouble."
To rectify that, TransUnion had to build a new category in its model. "It's not an installment loan for these trades," Pagel said. "But what we're going to have to do is ease these loans into the ecosystem, because even in a new category, there's still an attribute that goes into every score — one that says average age of trade. Buy now/pay later just can't go into that."
Equifax put infrastructure in place to support Pay-in-4 BNPL loans in February 2022 with the introduction of a "business industry code," a company spokesperson told American Banker.
"We took this step to formalize the process for including BNPL on traditional consumer credit reports. A business industry code is visible to lenders and service providers and classifies the industry in which the organization reporting credit information to Equifax functions," the spokesperson said, noting that the loans can be reported as an installment loan or a revolving line of credit, depending on how the BNPL provider's loans are structured.
Currently, BNPL lenders do not provide Pay-in-4 loans to Equifax, but "larger dollar and longer term point of sale loans are reported today and appear on consumer credit reports as revolving or installment lines of credit," the spokesperson said.
Experian worked with Affirm to develop a means for BNPL providers to send Pay-in-4 account information to the CRA using existing Metro 2 data reporting forms, a company spokesperson told American Banker.
For now, BNPL loans will only be visible to consumers on Experian. But eventually, lenders should be able to view the trade lines, too.
"When BNPL information is more widely reported to Experian from other leading BNPL providers, and the payment activity that's being reported is representative of the broader BNPL market and the ways in which consumers use BNPL products and services, a consumer's BNPL history will be visible to lenders who request to view it as part of an Experian credit report," the spokesperson said.
There's still another hurdle for the industry to overcome before lenders can actively use BNPL trade lines in their underwriting calculations: The credit-scoring companies such as FICO and Vantage Score need to incorporate it into their models.
FICO, for its part, worked with Affirm in what it called a "first-of-its-kind" study on how the inclusion of Pay-in-4 loans would impact its modeling, the companies said in February. FICO had been working with Affirm for about a year, Julie May, vice president and general manager of B2B scores, told American Banker.
The credit-scoring company looked at the FICO scores of half a million consumers who'd opened at least one Affirm BNPL loan, and compared them against a benchmark population of those who did not have an Affirm BNPL loan, she said.
"What we found with that is that you'd have higher scores or no score changes for the majority of the population of those users who had five or more BNPL loans," May said.
Specifically, FICO score impacts were generally consistent with the opening of a new account — within less than +/- 10 points for over 85% of the consumers in the study, according to FICO.
FICO was "aggregating separate BNPL loans together when calculating certain in-model variables," according to a Feb. 4 press release. May declined to comment further on how the proprietary model would ingest the loans, but noted that once live, it would be an update from a FICO product perspective.
Similarly, Vantage Score is waiting for more BNPL providers to send them data, and will still need to slow-roll the incorporation of BNPL loans into its model, Rikard Bandebo, executive vice president, chief strategist and chief economist at Vantage Score, told American Banker.
"Before lenders can start using it in their learning decisions, before we can start incorporating it into models, we've got to make sure we understand that we can treat it properly, so that it has the intended impact that it should," Bandebo said.
When these loans might be visible to lenders is anyone's guess, Bandebo said.
"A key stepping stone, which we haven't arrived at determining yet, is whether or not a change [to the model] is needed, and that has an impact on the timeline as well," he said. "That itself will determine pretty significantly how much more time is needed before it can be fully rolled out."
Getting it right
For lenders, making sure the model is fit for purpose is paramount for their credit underwriting operations, Fimanco's Newmark said.
"Underwriting models are going to have to be updated," he said. "It's a huge lift. It's thinking about new data. How is it relevant? How do you ingest it? How do you include it in the model? You have to go back and probably do regression testing on correlations.
"To not do it would just be derelict," Newmark said. "Once that data is available, I don't think you can avoid the genie out of the bottle. You've got to figure out how it impacts your probability of payment, how you want to include it in your model, how you weigh it, where you use it."
Cost of funds may also be impacted, too, depending on how the inclusion affects consumers' credit scores in the short or long term. Especially for lenders that securitize on the secondary market.
"Your FICO band is what's looked at as part of your securitization pricing," Newmark said. "If suddenly a large portion of your population were to have buy now/pay later loans and that was to reduce their FICO score by 20 points, that could affect the pricing on your securities."
It will take time, too, for lenders to update their own models, TransUnion's Pagel said.
"Most big banks and most fintechs have their own custom models. We're talking about millions of models out there that need to be changed in order to incorporate the data, and that takes a lot of time," Pagel said.
"The answers aren't there yet, because we haven't had a huge dataset to play with and to understand how to use it. But what I can say is, once we get it, it's going to be really valuable," she said.
Do BNPL companies report to credit bureaus?
There is currently no regulation requiring BNPL lenders to report their data to credit bureaus, although some do. Affirm reports all of its loan data to Experian, and Klarna reports application and finalization of a term loan, and on-time and overdue payments and defaults for its term loans to TransUnion. It does not report Pay-in-4 loans.
Would Pay-in-4 loan reporting affect credit scores?
Currently, Pay-in-4 loans do not affect consumer credit scores. In February, FICO conducted a study with Affirm on the impact of these loans on its scoring model and found that most consumers with multiple BNPL loans saw higher or no significant changes in their FICO scores. FICO is developing an updated model to incorporate BNPL loans.
Can credit scores accommodate BNPL loans?
Integrating BNPL loans, especially Pay in 4, into credit reports and scores is complex and requires widespread industry involvement. Klarna argues that current credit models are outdated and don't fit BNPL's bi-weekly, short-term, transaction-based nature. Klarna believes reporting positive repayment rates could lower scores under current models.
BNPL providers face operational challenges in reporting data, including handling disputes and ensuring regulatory compliance. Credit bureaus struggle to incorporate BNPL data due to its short duration and different payment behavior.
