Last Updated on 22 November 2022 by Dan
Hello everyone! If there’s one section of the economy right now that’s still going gangbusters, it’s online shopping. No matter if we’re giving ourselves a little treat to get through this or getting in those essentials it’s become a major focus of the way most of us shop. Increasingly, I’ve seen a payment option being offered online to pay for your purchase in instalments with an organisation called Klarna, so I investigated further….
NB: In the interests of transparency – when I write reviews I usually ensure I have tried and tested the product myself to reach a conclusion per our editorial policy. In the case of today’s review I should be clear I have not used Klarna directly as a customer, but have undertaken significant research on the topic.
How does Klarna work?
Klarna is actually technically a bank! Started in 2005, it’s one of the most successful fintechs in terms of growth in the last few years, coming out of Sweden – the growth rate and success story has been phenomenal, as it’s now involved in $21bn of online sales.
So as to how it works, let’s say you buy a table. If you purchase though Klarna you might split it into 3 payments – paying a third now, a third in 30 days and the final third in 60 days. Now the marketing spiel from Klarna has this as allowing you to enter a “try before you buy” arrangement – you hand over very little cash before you’ve actually seen your table, something people worry about in the internet age.
The selling point to you as a consumer is that you pay no interest on the bit that you’re paying later, and it doesn’t go on your credit report. You do pay interest and potential hits to your credit report if you make those payments late.
Klarna can also offer through some merchants slightly longer term payment plans which are more similar to classic consumer lending. In these cases there may be impact your your credit rating and interest to pay – it depends on the individual arrangement.
So you can easily understand the business proposition that Klarna is selling – if you’re a company is makes it easier for people to buy your goods, and if you’re a consumer you may have more flexibility with that purchase.
What is the catch with Klarna?
So…. if you only rigidly used Klarna in the way that the marketing says, dutifully borrowing for a very short term period and paying it back you might actually conclude it’s a good thing. In fact, you’re actually making a small gain because you’re borrowing money at no cost.
The danger or catch of Klarna is unfortunately much more subtle. They are a company and they need to make profit. Now they make some of their money by charging the merchant a small cut for you using the service, which is fair enough, particularly if it generates a sales lead.
However, also you don’t make profit by handing out money for free. Thus, on the consumer side of the business there’s a calculus in there that a number of consumers will miss their payments and go into debt with Klarna.
Whilst this is potentially likely to be on smaller purchases, it represents the beginning of the debt cycle – you couldn’t pay the thing off, so now you have to pay it back with interest…. which makes it even harder to pay off etc. etc. It’s an easy trap to fall into, with buy now now pay later approaches.
We at the Wilderness take a very simple and hard line – never use Klarna or buy now pay later services unless you absolutely, 100% need to.
Why I see Klarna as problematic
And there’s a few reasons I’m particularly wary of debt traps here, and see it as more of a risk than elsewhere:
The first is that Klarna is largely targeting themselves at young millennials, people in the 18-30 age bracket who are more likely to face uncertainty with their income, and are face lower incomes that may place them in a vulnerable position of finding they can’t make a payment and starting the debt cycle. In some but not all cases, member of this group may be less likely to think longer term about impacts their finances.
The second is that Klarna is largely focused on the purchase of non-essential goods – most of the retailers I’ve seen it appear on have been clothes sellers for example. Sometimes you’re forced to take on debt for the really unexpected and severe shocks in life, but I’d always say borrowing for what is ultimately a non-essential purchase is a pure no-no.
Thirdly is that Klarna creates bad psychological purchasing habits – we don’t like to admit it but we’re creatures of habit, and setting up a mindset where we buy something because we want it now, and we’ll worry about affording it later is not a healthy place to be for your money management – especially again for those in the millennial bracket.
It creates an illusion that everything is free, because money does not change hands. That’s already something can be an issue with a credit card, but when you don’t even see the numbers tick down on your bank account it’s even more difficult to manage.
If I can build on this point a little, various studies have shown that we humans are absolutely terrible at mental accounting – we often likely to be in come cases quite wildly optimistic about our ability to handle financial issues in the future, and this can lead us into trouble with services like Klarna.
I struggle to think of a situation where you’d absolutely need to have some new clothes right this second, and couldn’t wait till payday when you have the certainty than you can afford something because you know it’s gone out of your bank account.
Are Klarna clear on their fees?
In fairness to Klarna, their app is quite clear in terms of laying out what you owe and when you owe it, and you can set up reminders and notifications to make sure you don’t miss those deadlines by accident and incur charges you don’t need to. I see you can also ask once for a further 10-days without interest being charged again to clear a balance.
However I definitely have to give black marks to Klarna for a real lack of transparency on their fees and charging structure if you do miss payments.
The nice bits of “interest free” and “no credit rating” impact are literally all over their website, but good luck trying to find details of precisely what interest you’ll pay if you do miss a payment, with them instead “inviting you to call an adviser to discuss your options”.
I hope (I really do) that you would never sign a loan agreement without being clear how much you’re agreeing to pay back so I find this concerning. I found a range of estimates on what Klarna’s interest charges might be online, but was unable to fix this down.
Does Klarna affect my credit score?
Klarna are insistent that their processes do not affect your credit score. The reasoning for this is that they only run a “soft search” on you when setting up an agreement – a less intensive approach that doesn’t affect score.
However, searching around the internet there are quite a few documented cases in the press where Klarna customers have missed a payment and insist their credit score took a dive in the period afterwards.
Klarna themselves insist this isn’t possible, as even with a missed payment they say their processes is not to report you to credit reference agencies, which would usually be what would trigger the downgrade.
It’s difficult to reach a conclusion on this, as there are a large number of factors that affect credit score. If Klarna are doing what they say in respect of their processes, there isn’t any reason it should be Klarna driving this.
Does Klarna affect a Mortgage application?
There’s no clear answer on this, as there isn’t a fixed policy on how a bank or a building society would consider Klarna – but this answer is that it’ll have some effect as they’re likely to consider it as a form of credit. The much harder question is the extent it might cause issues.
Whilst Klarna is unlikely to appear in your credit score per the above, it is something banks and building societies may observe as a factor when going through your bank statements/financial history. as part of a mortgage application.
I believe most banks or building societies are likely think of Klarna as “unsecured credit” – so it would be equivalent to use of a credit card. If a lender is particularly restrictive it could end up in a harsher category (as something like a payday loan would) which could be more punitive.
If in doubt that this might cause issues for you, you should always have a discussion with your lender and do your own further research before engaging in any financial product.
Conclusions on Klarna
Whilst it markets itself as a whizz-bang new exciting fintech company, what Klarna is doing is really rooted in an older business model of catalogue shopping. You’d have received glossy brochures of clothes through the mail, which you could order on credit, but it had a reputation to leading some people into financial trouble who bought things despite being in a position they were unlikely to be able to pay it back.
It’s the same business model, just with a larger selection of catalogues from many online retailers.
Where you’re buying anything that’s an non-essential good, I would strongly advise against using a service like Klarna over simply paying for the product then and there. Why build a debt problem you don’t need?
Martin Lewis over at MoneySavingExpert has a rather excellent mantra which feeds throughout his whole website, and it’s very linked to what we believe at the Wilderness as well. It’s to challenge your purchases and ask two key questions:
“If you’re skint, ask if you need it and if you can afford it. If you’re not skint, ask will I use it and is it worth it?”Martin Lewis
Both questions there are important, but the first one is really important for what it can mean for your finances. Klarna encourages you to go against than mentality and conclude you might need something even when you’re in the skint bucket, and we can never encourage that here.
(P.S – On a similar money management topic, I’ve written about why you should never pay off just the minimum on your credit card, which I believe has some crossover with use of services like Klarna – you may want to take a read).
Jennifer at Monethalia also has an excellent post on why Buy Now Pay Later schemes are a debt trap in general.
Have you used Klarna or other buy now pay later services and had issues? Or do you have any other thoughts on questions on Klarna? Drop us a comment below.
And that’s it!
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