Fintech/Analysis/

Klarna: everything you need to know before you use it

Klarna is taking the world by storm, allowing online shoppers to pay later at no extra cost. But how does it work? And are there risks?

By Michael Stothard

Credit: Credit: Klarna

Klarna is a ‘Buy Now, Pay Later’ (BNPL) service that allows online shoppers to pay for products later in the month or in instalments at no extra cost. It means, in effect, that Klarna buys your clothes or other items for you. You then pay Klarna back at a later date if you want to keep them.

Unsurprisingly for a service that offers consumers something for nothing (i.e a free small loan), Klarna has proved explosively popular, particularly in recent years with a younger millennial audience who are more comfortable shopping online. 

The Swedish company, which started in 2005, now boasts 90m active consumers across more than 250,000 merchants in 17 countries, bankrolling people’s wardrobes all over the world. The service started in Europe but has since moved to conquer the US market.

Investors have been pouring money into the company. Klarna was valued at $45.6bn at its last private funding round this year, making it the highest-valued private financial technology company in Europe and the second most valuable fintech in the world. 

But as the company has grown so has the controversy around it with claims that Klarna (and other BNPL lenders such as Afterpay, Clearpay and Affirm) have been leading young people to overspend online and trashing their credit ratings. 

So what do you need to know about Klarna? 

How does Klarna work?

Anyone shopping online at participating retailers can, at checkout, select the ‘Pay Later with Klarna’ option. This means that Klarna will actually pay for the goods upfront. 

Shoppers then put their card details in with Klarna and agree to pay for the goods either in full 30 days later or split the costs into three monthly payments (with the first paid as soon as the item is shipped).

The two most popular options — paying in 30 days, or paying in three instalments — are always interest-free. But there is also a longer-term financing option that allows users to spread the costs of big purchases over a maximum of 36 months at an interest rate of up to 18.9%.

Klarna is particularly useful in a world where shoppers order lots of goods online and then send much of it back (because they are the wrong size, or don’t look good). It means customers never have to see any money leave their account for items they return within 30 days.

How does Klarna make money?

Klarna’s core BNPL services are free to customers but not to retailers who pay Klarna a small fraction of each interest-free loan they offer to shoppers.

Why? Well, retailers find that customers buy more online — some retailers say as much as 20% more — when they have to pay for the goods later rather than right away.

This means that sales for retailers go up which ultimately means more profits. That is why retailers like Topshop, H&M and ASOS use Klarna. 

Klarna also does make money directly from consumers from its “financing” option where users borrow money for longer at the 19% interest rate.

Can Klarna affect your credit score?

Klarna says that the classic BNPL products — paying in 30 days, or paying in three instalments — will not affect credit scores. If users do not pay, their accounts are simply blocked.

With Klarna’s ‘Financing’ option for longer-term borrowing, however, it performs a ‘hard’ credit check which anyone checking your report can see. Missing these payments will also affect credit scores. 

Be wary though that some other providers may have BNLP products that can affect credit scores.  One survey last year, conducted in the UK by comparethemarket.com, found that 22% of users had their credit scores negatively impacted by BNPL schemes.

Why do people criticise Klarna?

As well as potentially damaging people’s credit scores of those using “financing”, some argue that the service is also encouraging millennials to up their spending on sites like ASOS, Boohoo, Nasty Gal and PrettyLittleThing. 

“Klarna is, in my mind, a real Trojan horse for millennials’ finances. It’s coming at a time when fast-shopping has just gone to a new level,” wrote Iona Bain, founder of the Young Money Blog, last year.

Swedish politician Per Bolund said that customers should not be fooled into “payment paths that cost more”. He then promised to give companies like Klarna a “hard time”.

How does Klarna defend itself from the critics?

Sebastian Siemiatkowski, the cofounder and CEO of Klarna, points out that offering credit to retail customers is nothing new. 

What Klarna and other BNPL businesses do is lend money in a generally more consumer friendly and cheaper way. 

“Ask the big banks [how much they make in fees], ask the credit card companies,” Siemiatkowski tells Sifted, pointing to the 25% fee credit card companies generally charge.

Klarna’s service is, after all, free for most consumers.

Will Klarna and other BNPL services kill credit cards?

Credit cards were arguably the first ‘fintech’ phenomenon, allowing consumers to defer digital payments and then repay the debt in one lump sum. 

The catch was that late repayments came with double-digital interest charges, giving the big credit card providers — including Capital One, American Express and big banks — chunky revenues (the average US credit card holder pays $753.80 per year in charges).

But a decade later, BNPL rose to become the new tech-driven star of ‘point-of-sale credit’, allowing users to instantly defer payment over various instalments at zero interest across millions of merchants. 

Instead of relying on user fees, BNPL companies instead took a cut per transaction from retailers.

But experts say that BNPL service will likely co-exist with credit cards long term. Credit cards will remain more useful for big purchases and BNPL will be chosen by many for smaller online orders.

When was Klarna founded?

Klarna was founded in 2005 by three friends from the Stockholm School of Economics; Sebastian Siemiatkowski, Niklas Adalberth and Victor Jacobsson.

They entered the school’s annual entrepreneurship award with their idea on how to provide consumers and merchants with safer and simpler online shopping payment methods. 

They lost the competition but set up the company anyway and started offering services in Sweden. Three years later, Klarna expanded to Norway, Finland and Denmark.

The company’s growth has since been remarkable and it is now making a big push to conquer the US market. 

What are the alternatives to Klarna?

The biggest competitors to Klarna include Afterpay, Affirm, Clearpay, Sezzle, PayPal Credit and Splitit.

Not all of them offer exactly the same service. Splitit, for example, allows customers to pay with an existing credit or debit card, holding the full amount on their card and taking an instalment each month. 

To read more about Europe’s payments revolution, check out our report. Download it here.

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