Revolutionizing Credit Scoring: The Upcoming Shift with Buy-Now-Pay-Later Data Integration

Anticipate a significant transformation in how your creditworthiness is assessed starting this fall. The Fair Isaac Corporation, widely recognized as FICO, has announced the rollout of an updated scoring model that will incorporate data from buy-now-pay-later (BNPL) financing options. This development marks a notable shift in credit evaluation practices, reflecting evolving consumer behaviors and financial technology innovations.

Understanding the Rise of Buy-Now-Pay-Later and Its Impact on Consumers

In recent years, BNPL services have surged in popularity, especially as consumers increasingly turn to these flexible payment plans for everyday expenses such as groceries and household essentials. According to a Federal Reserve Board analysis from late 2023, approximately 14% of adults reported using BNPL loans at least once in the past year-up from 10% just two years prior. The report highlights that individuals facing credit constraints are among the most frequent users of these services. Additionally, a survey conducted by the New York Federal Reserve indicated that one in five households reported recent BNPL usage, underscoring its widespread adoption.

What makes BNPL attractive is its simplicity: minimal paperwork, no interest charges if payments are made on schedule, and typically four installment payments. Instead of earning interest, BNPL providers generate revenue through merchant fees paid by retailers, making it a mutually beneficial arrangement for consumers and merchants alike.

Criticism and Support: The Debate Surrounding BNPL

While BNPL offers convenience, critics argue that it may encourage over-indebtedness among consumers with limited credit experience, leading to multiple outstanding loans that can become difficult to manage. Conversely, advocates contend that integrating BNPL data into credit scores can serve as a bridge for consumers who lack traditional credit histories, enabling them to qualify for larger financial products such as mortgages or auto loans. Julie May, FICO’s Vice President of B2B Scores, emphasizes that this inclusion could provide a more comprehensive picture of a consumer’s credit behavior, especially for those who have previously been underrepresented in credit reports.

Gerri Detweiler, a seasoned personal finance author and credit expert with over three decades of industry experience, supports this perspective. She notes that not everyone opts for credit cards or auto loans, and BNPL data could help these individuals establish or improve their credit profiles. Consumer advocates generally agree that this update aligns with FICO’s goal of expanding access to credit, provided that responsible borrowing is maintained.

How FICO Scores Are Calculated and What’s Changing

FICO scores are derived from a combination of factors: debt levels constitute about 30%, payment history accounts for roughly 35%, while other elements include the length of credit history, credit diversity, and recent credit inquiries. These data points are collected by the three major credit bureaus-Experian, Equifax, and TransUnion-and used to generate your score.

Historically, FICO models evaluated a consumer’s credit profile based on a snapshot in time. However, since 2020, FICO has incorporated models that analyze debt trends over a two-year period, providing a more dynamic view of credit behavior. The upcoming models, including the latest versions like FICO 10T and F10, will integrate BNPL activity, offering lenders a clearer picture of a borrower’s financial habits.

By including BNPL data, FICO aims to identify “phantom debt”-obligations that are not reported to credit bureaus but influence a consumer’s overall debt load. This can reveal whether a consumer is managing their debt responsibly or accumulating unreported liabilities. Adam Rust, Director of Financial Services at the Consumer Federation of America, explains that this transparency can assist lenders in making more informed lending decisions.

Major BNPL providers such as Affirm and Klarna have expressed support for these updates, viewing them as beneficial for consumers by providing a more accurate reflection of their credit activity.

Will Lenders Adopt the New FICO Scoring Models?

The adoption of these new scoring models by lenders remains uncertain. Implementing the updated scores requires investment in technology, staff training, and adjustments to existing credit assessment processes. Ted Rossman, a credit card industry analyst at Bankrate, compares this transition to upgrading smartphone operating systems-many lenders still operate on older versions like FICO 8, which remains the most prevalent.

Fannie Mae and Freddie Mac, the primary government-sponsored entities backing the mortgage market, initially planned to adopt FICO 10 this year. However, their plans have been postponed, though their eventual adoption could accelerate industry-wide changes. Consumers should be aware that different credit scores may be used for various types of credit-such as mortgages, auto loans, or credit cards-since FICO offers multiple scoring models tailored to each sector.

Additionally, VantageScore, another prominent credit scoring provider, offers alternative algorithms that may also influence lending decisions.

Potential Effects on Your Credit Score

The precise impact of the new FICO models on individual credit scores remains uncertain until they are widely implemented. For now, BNPL providers like Affirm and Klarna are already reporting some of their data to credit bureaus, which could influence scores once the new models are in use. However, not all BNPL firms are reporting data yet; for example, Afterpay’s parent company has indicated they will wait until there is more evidence that sharing BNPL data does not harm credit scores.

Consumers should focus on maintaining responsible credit habits-paying bills on time, keeping balances low, and monitoring credit reports regularly. Michelle Singletary, a personal finance columnist, emphasizes that consistent, timely payments are the most effective way to safeguard your credit standing.

Overextending on multiple BNPL loans simultaneously can lead to financial strain, overdraft fees, and increased interest payments on credit cards. If debt becomes unmanageable, seeking assistance from a certified credit counselor through organizations like the National Foundation for Credit Counseling (nfcc.org) is advisable.

What You Can Do to Protect Your Credit

For consumers who do not utilize BNPL services, the upcoming changes are unlikely to significantly affect their credit scores. Since credit mix accounts for only about 10% of the overall score, the absence of BNPL activity will have minimal impact. As Teresa Murray from the U.S. Public Interest Research Group notes, “Not having BNPL transactions on your credit report poses no negative consequences.”

In summary, while the integration of BNPL data into FICO scoring models promises a more comprehensive view of consumer credit behavior, responsible borrowing remains key. Staying current on payments and managing debt levels are the best strategies to ensure your credit profile remains healthy amidst these industry shifts.