Credit scores will get a buy-now-pay-later update. Here’s what that means.

The way your credit score is calculated may change this fall. The Fair Isaac Corporation — commonly known as FICO — announced in June a new version of its scoring algorithms to include buy-now-pay-later loan data.

The change comes as consumers increasingly rely on BNPL to cover essentials like groceries. A recent Federal Reserve Board research post reported that 14% of adults in fall 2023 had used these kinds of loans at least once in the past 12 months, compared with 10% two years earlier, and noted that “credit constrained” consumers are among the most likely to turn to those loans. Another survey, from the New York Federal Reserve, estimated that 1 in 5 of all households in 2023 reported using them recently.

The appeal of these loans is that they require little paperwork and don’t charge interest as long as the installments, usually divided into four payments, are on time. (In lieu of interest income, BPNL lenders make money through merchant fees that retailers pay.)

BNPL lending, more broadly, has come under criticism for encouraging credit-poor consumers to load up on debt through multiple loans. However, supporters of the FICO change say it will help people who otherwise haven’t used credit products to qualify for other, bigger loans. “This can actually give them a bridge to be able to get credit data in the credit reporting agency files,” said Julie May, vice president and general manager of B2B Scores at FICO.

“It’s a good move to include buy-now-pay-later data. Not everyone wants a credit card, not everyone needs a car loan,” said Gerri Detweiler, a personal-finance writer and credit expert who’s been monitoring the industry for more than 30 years.

Independent consumer advocates also generally agree that this update could serve FICO’s intended goal of helping more people gain access to other credit products — such as credit cards, mortgages, and auto loans — especially if they’re using the loans responsibly.

“For people who don’t have mortgages or credit cards, this could be a way for them to build a credit record, as long as payments are made on time and reported accurately,” said Teresa Murray, consumer watchdog director at the U.S. Public Interest Research Group.

Here are the key things to consider about these installment loans.

FICO rates consumers on various factors: The amount of debt owed accounts for 30% of the score; timely payment of debt is another 35%; and the remainder incorporates factors such as the length of credit history, the credit mix, and how many new lines of credit have opened. This data is compiled by the “Big Three” credit-reporting bureaus — Experian, Equifax, and TransUnion — and is then used by FICO to calculate your score.

FICO uses multiple scoring models, but traditionally, they have looked at a consumer’s data as one snapshot in time. In 2020, however, FICO added a new model that looks at balance activity over two years to see whether it’s trending in a positive or negative direction. It’s this version (dubbed 10T) that will incorporate BNPL activity; its newest static model, F10, will also use this data.

By adding in BNPL loans, FICO can better capture what Adam Rust, director of financial services at the Consumer Federation of America, calls “phantom debt” — debt that isn’t being reported to the credit agencies and therefore is hidden from lenders. Consumers could be in more debt than they’re able to handle, or they could be paying off purchases in a timely way. If lenders can see this data, he said, it helps them determine a borrower’s ability to repay them.

In statements to the Washington Post, Affirm and Klarna — two of the most well-known BNPL lenders — said they welcomed these updates as beneficial to consumers.

Time will tell. Lenders will need time and money, as well as personnel training, to use the new scores, noted Ted Rossman, a credit card expert at Bankrate. FICO reports that 90% of lenders use some version of its models, with FICO 8 the most widely used.

“It’s kind of like the iPhone. Apple has the 16, but a lot of people are still using the 15, 14, or the 13 or even older versions,” Rossman said. “Credit scoring is the same way, and lenders are slow to upgrade.”

Fannie Mae and Freddie Mac, the two biggest government-sponsored enterprises that provide federal backing for mortgages, had planned to upgrade to FICO 10 this year, Rossman said. The agencies have since delayed the plan, but when this does happen, it “could actually be a big catalyst for change,” he added.

For now, consumers should also remember they have more than one credit score. FICO, for example, tweaks its base models to fit various industries. The algorithm used for mortgage approval may be different from the one used to get an auto loan or a new credit card.

And FICO is just one name brand, albeit a dominant one. VantageScore also provides some credit scoring algorithms.

The impact on your score remains unclear. The new version won’t be available until the fall, and consumers would have to know whether BNPL loans are being reported to all three credit reporting bureaus to see if there’s an effect.

Many things “have to go right” for this change to impact scores, Rust said. BNPL companies first have to decide whether to send in the data to the three major credit bureaus. Then, the lenders who rely on FICO scores have to decide whether it’s worth the cost to use FICO’s latest model. And both factors aren’t a guarantee.

And just as it costs money for the lenders to use the new model, it also costs the BNPL firms to furnish their data to all three agencies. They may well also need to hire more staff to deal with disputes, said Marshall Lux, a visiting fellow at the Psaros Center for Financial Markets and Policy at Georgetown University.

For now, some BNPL lenders are already reporting their data. Affirm reports data on all its installment loan products, including short-term payments of four-installment loans, to Experian and TransUnion, while Klarna supplies data on its long-term loans to TransUnion.

By contrast, Afterpay’s parent company, Block, said in a blog that it won’t report to the credit bureaus until there’s more evidence showing BNPL data doesn’t harm credit scores.

The only way to limit any negative impact is to keep to the same rules for credit card use overall. The Post’s personal finance columnist, Michelle Singletary, stresses the importance of paying your debts on time and lowering your balances for boosting a low score.

You should also remember that overreliance on the easy access to credit can lead to having too many buy-now-pay-later loans come due simultaneously. As the Federal Reserve Board post cautioned: “Consumers spend more when BNPL is offered when checking out and … BNPL use leads to an increase in overdraft fees and credit card interest payments and fees.”

If you’re struggling with debt, find a credit counselor at the National Foundation for Credit Counseling (nfcc.org). You also need to check your credit reports often to look for inaccurate information.

For those consumers who don’t use these loans, though, the impact from the FICO change should be minimal. Credit mix accounts for only 10% of your overall score, so whether you use buy-now-pay-later loans or not won’t affect your score in a significant way.

“There are absolutely no negative repercussions for not having this type of transaction on your credit file," Murray said.