How does buy-now-pay-later make money if it charges no interest?

Buy now, pay later, or BNPL, is short-term debt that lets you pay only part of a purchase's value up front, with the rest postponed or split into instalments. The idea is old: instalment plans emerged in the 19th century so people could buy expensive goods like furniture, pianos and farm equipment they could not pay for outright. What is new is the speed. In the early 21st century, fintech firms built instalment lending into the checkout of online shops, giving instant credit at the point of sale.

At checkout the financier typically does a soft credit check, decides within seconds, and pays the shop if you are approved. You then repay in instalments. The service is free to the customer as long as repayment is made, so where does the money come from? First, from the shop. BNPL financiers take a cut of the purchase price, with processing fees of 2 to 8 percent per transaction, compared with 1.3 to 3.5 percent for credit cards. Merchants are typically prevented from passing that cost on to customers by a no-surcharge clause.

There are other income streams. Interest is typically low or absent but can sometimes be as high as 30 percent, and late fees are typically charged to those who fall behind. Persistently delinquent accounts may be sold to debt collectors.

How risky is it for the lender? US data found that BNPL accounts default less than credit-card accounts, perhaps because many require automatic repayment: between 2019 and 2022, roughly 2 percent of BNPL-linked accounts defaulted, against 10 percent for other credit accounts.

Questions remain. Research at Harvard Business School found people spend more with BNPL instalments than with a credit card, and in many countries the industry is unregulated or self-regulated.