Savings.com.au investigates the finer points of buy now, pay later schemes like Afterpay and Zip, plus the impact they may have on your finances.
The evolution of payment technology over the past few decades is quite startling.
The prototype of the modern-day credit card was the Diners Club charge card, introduced as recently as the 1950s by New York Businessman Frank McNamara. Old Frankie Mac is said to have come up with the idea after suffering the indignity of requiring his wife to pay the bill at a restaurant because he forgot his wallet.
Since then we’ve seen a wave of innovation hit the payments landscape around the world.
Australia has been at the forefront for a lot of this, with credit and debit cards becoming commonplace in the country during the 70s and 80s. Now, most of our banking is done online and the majority of banks in Australia allow users to pay with their phones and even their watches.
The latest innovation to dominate payments technology discussions in the last couple of years is the emergence of buy now, pay later schemes in Australia, mainly Afterpay and Zip.
Throughout this article, we’ll cover the basics of how buy now, pay later works, how its two biggest players in Australia (Afterpay and Zip) make money, and what the pros and cons are of using such platforms.
Buy now, pay later in Australia – a summary
The basic premise of buy now, pay later isn’t too different from that of the standard credit card. After all, a credit card uses ‘buy now, pay later’ in that you pay for something on credit and pay it off at a later date, and not doing so results in interest charges.
But securing a credit card typically requires approval after completing an application that includes proof of income. Conversely, buy now, pay later providers generally allow anyone aged over 18 to use their services.
Buy now, pay later is already an enormous industry in Australia. Research from Roy Morgan found that in the 12 months to January 2019, 1.59 million Australians had bought something through Afterpay or Zip at least once.
These two platforms aren’t the only ones, but they are the biggest by far. According to Roy Morgan, Afterpay is used by 6.9% of the population, while 39.9% are at least aware of it. Zip’s two brands – Zip Pay and Zip Money – are used by 2.3% of the population (in total), and are known by 33.4%. Other buy now, pay later services available include:
Afterpay and Zip are the two current titans of by now, pay later, so they’re the ones we’ll focus on here.
Who uses buy now, pay later?
As you can see in the graphic above, these platforms are popular with the younger generations, which is unsurprising when you consider their marketing is almost entirely targeted at them. According to Roy Morgan, 40.6% of buy now, pay later transactions are made by millennials, while Gen Z occupies another 35.1%. Gen X (1961-1975) is 19.1% of transactions and boomers and pre-boomers account for the remaining 5.2%.
How does Afterpay work?
Afterpay’s premise is simple: by paying for your shopping using the app, you can take it home before you’re finished paying for it. With Afterpay you have to pay for at least a quarter of the payment up front, while the rest can be repaid in fortnightly instalments.
Here’s what Afterpay’s payments section looks like, including an option to pay any current balances instantly.
It’s connected to a large variety of stores, and when making a purchase you’re given a randomly-generated barcode which the retailer then scans.
There’s no credit check when signing up to Afterpay: you just need to be at least 18 and have a debit or credit card you can link to your account.
However, it does adjust your credit limit based on your repayment history. At first, it usually sets a limit of $500 for debit cards and $1,000 for credit cards, and you’re cut off from using Afterpay further once these limits have been reached. But if you demonstrate you can pay off your Afterpay balances on time every time, your available limit will increase to a maximum of $1,500.
If you fail to meet your repayments on time, you’re cut off from making further purchases through Afterpay until all late payments have been cleared. Afterpay also charges users late fees, which are one of the company’s biggest sources of revenue.
How does Afterpay make money?
There are two main ways Afterpay makes money:
- Late fees
- Merchant fees
The structure of Afterpay’s late fees are simple: you’re charged $10 for not meeting a repayment by the due date, and another $7 is charged if you fail to meet the repayment within seven days from the due date. Afterpay charges these fees instead of charging interest. But the late fees still have the ability to stack up on unsuspecting customers. Missing all four repayments on a $300 purchase, for example, can see you charged up to $68 in late fees.
Afterpay has attracted a volley of criticism from many industry stakeholders over late fees, with some saying it’s inherently predatory in nature. But according to Afterpay’s data:
- A vast majority (93%) of Afterpay transactions incur no late fees (How Millennials Manage Money report, commissioned by Afterpay Touch Group)
- Less than 20% of Afterpay’s total income comes from late fees (Afterpay H1 FY19 report)
Also, Afterpay has caps on late fees for smaller purchases. According to their terms of service:
- (a) For each Order with an Original Order Value below $40 – a maximum of one $10 Late Fee may be applied
- (b) For each Order with an Original Order Value between $40 and $272 (inclusive) – the aggregate sum of the Late Fees applied in relation to the Order will not exceed 25% of the Original Order Value (e.g. a $108 Order will have up to $27 (25% x $108) of Late Fees applied)
The majority of the platform’s income is derived from merchant fees (that’s fees Afterpay charges the store for purchases made using its platform). Afterpay has 2,800 retail partners, which includes major brands like David Jones, Adidas, Country Road, The Iconic and more.
According to its half-yearly report, Afterpay takes a cut of 3.7% of every transaction in merchant fees – a $100 transaction means Afterpay collects the $100 and sends the store $96.3. The idea behind this business model is that despite giving a portion of each sale to Afterpay, stores will earn more through increased sales.
How does Zip work?
Zip Co, which is partially-owned by Westpac, has a few different brands:
- Zip Pay: account limit under $1,000
- Zip Money: account limit over $1,000
- PocketBook: A popular budgeting and expense tracking app
Zip Pay, the company’s more profitable and most popular service (according to its reports), is the one we’ll be focusing on here, as it’s also the most similar to Afterpay.
Zip Pay functions in very much the same way as Afterpay does: you create an account in a matter of minutes, link a credit or debit card, generate a code at the counter and pay off your balance in instalments. Unlike Afterpay, Zip says it does actually perform credit checks on applications to determine your credit limit.
Zip actually allows users to choose how often their repayments are made based on their preferences, be it monthly, fortnightly, weekly or instantly. You receive a statement on the first of every month, and like Afterpay, you pay late fees if the entire balance isn’t fully paid off. But Zip Pay’s fee structure is a little different.
How does Zip make money?
Zip also makes money through late fees accrued by a small portion of its near 750,000 customers and merchant fees from more than 10,000 merchants. The merchant fees range from 2-4% plus 15 cents per transaction. Like Afterpay, these merchant fees account for the majority of its revenue stream.
Zip Pay is also ‘interest-free’ (Zip Money charges interest after the first three months) – instead it has two flat fees:
- $6 a month, waived if the full balance is paid off by the end of the following month from the purchase date
- $5 late fee if the minimum monthly repayment of $40 isn’t paid within 21 days after the due date
These fees stay the same no matter how much you owe, whether it’s $50 or the full $1,000. That means you’re paying an interest rate that’s effectively higher the less you owe.
What are the dangers of using buy now, pay later?
Based on what we’ve told you so far, there are some obvious and not so obvious reasons why using Afterpay and Zip isn’t always a good idea.
You can accrue unnecessary late fees
You might’ve picked up on this already given what we explained above.
Although the late fees on these platforms aren’t massive, they can add up over time, especially if you can’t afford to pay off your debts for an extended period. With Zip Pay, for example, if you hit the $1,000 credit limit and only pay the $40 a month minimum repayment each month until it’s paid off, you’d have been charged 25 lots of $6 monthly fees, which is $150 extra. Add a few $5 charges for not making the minimum repayment on time and you’d be paying even more.
Minimal credit checks
The average Australian is…not good with credit. Reserve Bank calculations show credit card debt is roughly $2,000 per person. And people who have debts will find it harder to acquire new credit cards since these debts and missed repayments will go on their credit reports, warning future lenders about their bad behaviour.
Compared to credit cards, Afterpay and Zip are not as strict with their credit checks. So even the most irresponsible spender could potentially use these platforms.
There’s the temptation to overspend
Spending with Afterpay and Zip is easy – so easy it can lead you to spend more than you otherwise would. A review of buy now, pay later arrangements by ASIC in November 2018 found ‘the majority’ of these users admit easy credit lead them to spend more than they otherwise would.
One in six users reported experiencing at least one negative impact as a result of using buy now, pay later services, such as delaying bill payments, becoming overdrawn and having to borrow more money from family or other loan providers.
As at June 2018, the average transaction value through buy now, pay later is $178, which is significantly less than the $1,098 it was in April 2016, due to both providers tightening their responsible lending practices.
The data below from Zip’s 2018 annual report shows most purchases are made on non-essential items like fashion, instead of ‘essentials’ like bills or groceries.
Of course, there are those who argue that using these services actually helps curb their everyday spending – we’ll cover this in greater detail in the ‘positives of buy now, pay later’ section shortly.
It can affect your ability to apply for credit
Lenders may not take kindly to buy now, pay later customers when reviewing their application for a big loan (e.g. home loans or car loans), despite the fact these services don’t have a direct impact on credit scores.
Lending requirements have tightened somewhat since the Royal Commission, with tales told of lenders knocking back applicants because they overspent on Uber Eats, or had an outstanding Afterpay balance.
Spending with Afterpay and Zip instead of buying outright could be regarded as simply shifting debt to another vehicle, so lenders will still consider this alongside your debts, expenses and overall risk profile before deciding to give you a loan.
They’re just so easy to apply for
As a test, I decided to apply for both Afterpay and Zip Pay to see how long it would take and what the general process is. The only steps were the kind you’d expect when signing up to any other website:
- Creating a username and password (complete with a “yes” or “no thanks, I don’t like great deals” option when asked by Afterpay to sign-up to their newsletter)
- Providing your phone number
- Entering a verification code sent to your phone number
- Entering your name and date of birth
- Entering your bank account information (not required immediately)
There’s an extra step involved with Zip where they ask to verify your identity, either through social media, BPAY or your bank account. This led to the Zip Pay application taking slightly longer.
Overall though, there was little to no effort involved in signing up, which is one of the major selling points for both platforms – they’re designed for you to be able to sign-up at the counter as you’re about to pay.
Here’s how long it took me to sign-up for Afterpay (left) and Zip Pay (right):
That’s one minute and eleven seconds it took to sign-up for Afterpay (granted I was hustling to get it done quickly). Of course, a fast application process can also be a positive feature of buy now pay later platforms, as long as they’re used responsibly.
Are there any positives to using Afterpay and Zip?
Buy now pay later isn’t all bad. There are actually legitimate reasons why you might want to use them.
The main benefit is the ease of application – we mentioned this as a negative before, but the fact that it can take as little as 1-2 minutes and doesn’t require a credit check makes them much easier to sign-up for than credit cards or even debit cards. Combined with the fact that you can start using them instantly (instead of waiting for a card in the mail) makes them much more appealing for time-poor consumers.
Also despite the merchant fees, it’s often cheaper to buy with Afterpay and Zip online since they sometimes have special deals running.
The repayment framework is simple, and depending on the type of customer you are, you might prefer to spread out your repayments instead of bulk-buying the whole thing at once. After all, you might have to do some shopping while you wait for payday, so buy now, pay later can help manage your finances. According to Afterpay’s ‘How Millennials Manage Money’ report, 57% of millennials (the biggest users of buy now pay later) use Afterpay because they feel it helps them better manage their finances.
Finally, the late fees on these services are often far less than the interest costs you’d end up paying on similar purchases with credit cards.
Afterpay & Zip vs credit cards
Afterpay’s report found credit cards are starting to go out of fashion: Just 41% of millennials now own a credit card versus two-thirds of older generations. Around 14 years ago, 58% of young people owned a credit card.
Millennials are also 37% less likely to own a credit card because they see them as being too risky and too costly – they have about half as much credit card debt compared to older generations. The overall number of credit card accounts has also fallen by 5% year-on-year across all age groups, according to RBA data.
So why are buy now, pay later platforms more becoming more popular than credit cards? There might be a few reasons:
- Afterpay and Zip are easier to apply for: minimal credit checks and applications take minutes, compared to credit cards which take much longer, require more documentation and take days to send a physical card
- The penalties of missing repayments are smaller: $10 fees pale in comparison to interest rates as high as 20% or more in interest. We’ve run some calculations on how credit card interest can accumulate (the answer is quickly)
- The staggered repayment plan of Afterpay can help with discipline and budgeting: unlike credit cards, which simply charge you interest on any outstanding debt remaining on the card by the interest-free period
- Easier choice: there are dozens and dozens of credit cards on the market, but Afterpay and Zip work essentially the same way for everyone.
- Afterpay and Zip have smaller credit limits: this can also be a bad thing, but a lower credit limit means you can’t easily accrue thousands and thousands of dollars of debt. Afterpay and Zip Pay also stop you from making further purchases once you’ve missed a payment, which credit cards don’t do until you hit your credit limit.
So with all of this information in mind, should you use Afterpay or Zip?
Savings.com.au’s two cents
All things considered, Afterpay and Zip are not bad products. Sure, they have their flaws – they can encourage reckless spending, acquire late fees you wouldn’t get with spending outright and can generally get you into trouble.
But these issues are only a problem if you lack discipline. If, for example, you used by now, pay later platforms for spending you’d do anyway, then they can be very useful for spreading your spend over several weeks/months.
Plus, certain outlets actually offer discounts for people who shop using either of these services, so you can actually save money on some transactions.
If you do decide to use these services, just make sure you don’t spend more than you normally would, and always make sure you pay off all balances you accrue.
Given the majority of buy now, pay later users are the younger generations, it’s increasingly likely these platforms represent the future of payments – they won’t be going away any time soon.