At the start of the pandemic, when online shopping was many people’s favorite pastime, “buy now, pay later” plans exploded in popularity. The idea wasn’t exactly new—it’s not unlike paying for your TV with a layaway plan, if you remember those. Except with BNPL, as it’s called, you get your item immediately, usually, for only a small down payment. The rest, you pay off in installments. Especially for Gen Z, BNPL was seen as a trendy new financial product and a “safer” alternative to credit cards.
The problem with BNPL is that, if you don’t follow all the rules, there are consequences. Many consumers have found themselves overwhelmed by the massive balances they’ve racked up using these apps, and those consequences are becoming clearer. On Sunday’s episode of What Next: TBD, I spoke to Paulina Cachero, personal finance reporter for Bloomberg, about how the real cost of “buy now, pay later” apps is becoming clear—just in time for holiday shopping. Our conversation has been edited and condensed for clarity.
Lizzie O’Leary: Let’s say I buy a pair of shoes that cost $200. If everything went right, how does BNPL work? What would happen?
Paulina Cachero: You would pay a small down payment, let’s say 25 percent of that purchase, and then from the date of that purchase you would be charged, typically, four installment loans over six weeks.
To sign up for these services, all you have to do is put in your credit card information or your debit card information, and that service will automatically charge you whenever the date for that installment loan is due.
BNPL companies make most of their money by charging retailers a fee for using their services, usually somewhere between 2 and 8 percent of the purchase.
The value proposition they give to merchants is that [their internal research] shows when customers use “buy now, pay later” services, on average their checkout cost is bigger. People are spending more using “buy now, pay later” services because there’s a sense that “I’m not feeling the financial burden of this purchase right now. It’s spread out over time.” I think that it convinces consumers that they can buy more because they’re not going to see the full amount of that balance automatically deducted from their bank account.
The marketing for these apps is all about how they are a safe alternative to credit cards, with no interest and no fees if you pay on time. If you do everything right, that’s true. But if not, things start to get tricky. Let’s say I miss a payment. What happens then?
This is one of the things that the Consumer Financial Protection Bureau cited as a risk to consumers. There’s really inconsistent consumer protections. Every “buy now, pay later” service has different terms and conditions on what happens if you fall behind on payments. You can incur anything from late fees to interest on whatever money you borrowed. Sometimes that’s more than what you would incur on a regular card.
So they say there’s no interest, but actually there is interest?
Yeah. BNPL firms like to advertise themselves as risk-free credit options. But it’s only free if you follow all the rules. Many consumers complained to the Consumer Financial Protection Bureau that these BNPL firms aren’t disclosing the costly hidden fees and interest rates that can be incurred when someone falls behind on payments.
One survey from Credit Karma earlier this year found that a quarter of respondents saw their total debt increase after using the apps, and more than 20 percent ended up using credit cards to pay down their BNPL balances. This is the hidden interest that people talk about. You’re paying double the interest if you’re falling back on payments, if you’re using credit to pay back credit you’re taking out.
So it’s loans on top of loans.
It’s loans on top of loans. But people don’t think about it that way because “buy now, pay later” services are not advertising themselves as loans, and until this year they weren’t treated as loans or credit.
What do we know about who is most likely to use “buy now, pay later”?
I’m sure you’ve read a ton of stories that Gen Z is using “buy now, pay later,” all the time. The most recent Consumer Financial Protection Bureau pointed out that actually the biggest age cohort for “buy now, pay later” users are people ages 34–40. They’re millennials.
For the most part, I think a lot of those customers are using “buy now, pay later” responsibly because they understand that while they might not be advertising themselves as a loan, they are. Older consumers probably remember the layaway plans of the early aughts, and “buy now, pay later” is like that, repackaged with an instant gratification twist. I think that’s allowed them to use “buy now, pay later” services responsibly, and in a way that actually helps them manage their finances.
Younger consumers who don’t really understand that or didn’t work with layaway plans, they don’t understand that. They’re the ones who are more likely to fall behind on payments and become delinquent.
I’m also really curious about someone who has a lower income, doesn’t have a credit card, or didn’t qualify. What do we know about their usage of BNPL?
“Buy now, pay later” services offer soft credit checks and access to credit that they may not get otherwise. In a story that I worked on, I talked to a young consumer who was paying her own way through college. She actually tried to apply for credit cards and got rejected. She’s a woman of color. She just didn’t have any credit history.
I think [BNPL] appeals to a demographic that might not have the credit history to get a credit card. This is credit that they can actually access. There’s a huge percentage of people who are of lower-income communities who do use “buy now, pay later” services.
In the normal consumer finance world, if I apply for a card and Equifax or TransUnion, one of the big credit agencies says, “Lizzie’s kind of overextended on her other debts,” they’re not going to give it to me. And yet, it sounds like that might happen here. Is anyone checking to make sure that the people who are using these services can pay for them?
That’s a bit of a black box at the moment. A lot of these “buy now, pay later” firms claim to run soft credit checks, but we don’t know what that means. One of the things that the Consumer Financial Protection Bureau cited was that most firms can’t accurately assess their underwriting because they’re not reporting to major credit reporting bureaus.
It’s pretty common for consumers to use multiple “buy now, pay later” services at once. This is a practice known as “loan stacking.” That’s not something “buy now, pay later” firms can assess when they’re looking at their customers. AfterPay doesn’t know if a customer has a loan with Klarna, or Zip, or any other number of services. That wouldn’t be the case if they were applying for a credit card.
On the one hand, it seems like it’s great. If you get in trouble, it’s not going to ding your credit score. On the other, you can get in trouble really quickly.
Yeah. If you talk to “buy now, pay later” firms, they will say that they haven’t started reporting to these credit bureaus because the way that they’re assessing what are effectively short-term loans isn’t beneficial to consumers. They say they’re on the consumer side. They don’t want to report loans that could hurt consumers’ credit scores.
Because every time there’s an inquiry it shows that in your credit score?
Right. There might be a case for that argument, but if you can’t assess how many other loans customers are taking out at once, that seems to be riskier. As of right now, I don’t believe they have started reporting to credit bureaus. While they say that they’re not actively sending consumer data to these credit reporting agencies, there are still other ways that these “buy now, pay later” loans can make their way to credit histories.
For example, if you fall behind on payments and a “buy now, pay later” service decides to send that loan to a third-party debt collection agency, that debt collection agency could report it and that could make it onto your credit history.
Even though they’re not the largest demographic group using BNPL services, Gen Z seems particularly vulnerable to ending up in debt. In your reporting, you found college students and 20-somethings who got themselves quickly and sometimes naively overextended. Why?
They thought that “buy now, pay later” services were a safer alternative to credit cards. That made “buy now, pay later” services particularly attractive to young consumers who may not have credit history, many of whom graduated in the pandemic and in this economic downturn. They didn’t have as much money and maybe struggled to find jobs right out of college. It was a way for them to get credit and to avoid these horror stories about falling into debt with credit cards.
If you use more than one BNPL app for more than one purchase, over a short period of time the debt can quickly spiral out of control.
While these installment loans seem simple enough, a lot of people have trouble actually keeping track of what they owe and when. These repayment schedules can quickly become confusing. Imagine you’re making a number of purchases on different days of the week with more than two dozen services available, all offering different terms and conditions, some of them working on different payment schedules. A lot of the “buy now, pay later” services require this mandatory autopay. Whenever you sign up with your credit or debit card, they can automatically charge that card that you have on file. So, that’s how people are falling behind on payments. I saw some users talking about “I couldn’t even keep track of what I was spending, and then it was time to pay my rent and I had no money in my bank account.”
Washington has begun to notice that BNPL companies have exploded in popularity, leading to congressional hearings. Is any of this regulated?
The Consumer Financial Protection Bureau, and actually a lot of financial regulatory bodies in New Zealand and the U.K., have started to crack down on this. That’s because while “buy now, pay later” services started out primarily for retail purchases, with inflation hitting a 40-year high, people have started to use them for things that they need like groceries, rent, medical bills. It’s not just for these material purchases like new clothes or makeup—it’s for things that they actually need.
In reading your reporting and another Bloomberg story, I noticed that the way the BNPL services are set up, they actually avoid being scrutinized under the Truth in Lending Act. That law, which is from the 1960s, requires a lot of disclosures if consumer loans are split into five payments or more. But here, we’re generally talking about four payments. Does that make you wonder: Was that a conscious choice in the way these things were set up, this sort of regulatory gray area?
The “buy now, pay later” sector has faced criticism because they haven’t been subject to the same regulatory oversight that normally applies to lenders. As you mentioned, the Truth in Lending Act is this landmark law that requires pretty extensive disclosures for unsecured consumer loans. “Buy now, pay later” services don’t apply to that.
The Consumer Financial Protection Bureau announced some of the most extensive regulations to the sector in September. That includes identifying surveillance policies in the industry that need to be curtailed, and the collection of consumers’ purchases and demographic data for targeted ads. They also said that “buy now, pay later” providers will have to undergo supervisory examinations similar to those applied to credit card companies. And they’re really ramping up trying to create options for these companies to send their data to credit reporting agencies.
There is a tremendous amount of consumer data collected in this process. Your granular purchases, what you’re browsing on, all of that stuff gets sucked into these companies’ services. What happens to that data?
A lot of the “buy now, pay later” providers are actively harvesting and monetizing consumer data across these payments and lending ecosystems. They’re using this data to deploy models, product features, and marketing campaigns to increase the likelihood of sales and maximize the value that they can get from those customers.
After spending time writing about these companies and talking to consumers, are you willing to take a guess? What’s the future of these services? Was this a short-lived blip, or are they here to stay?
To be honest, I don’t think that the “buy now, pay later” installment loan financing option is an issue itself. I think it’s the lack of regulation and protections, and the way that these providers have been allowed to flourish without answering to the same regulatory oversight of credit cards and traditional lenders. I think the way that these “buy now, pay later” providers will be able to give credit to consumers and how they’re able to use data from consumers will be changing soon.
We’re obviously heading into one of the biggest shopping times of the year. Are you going to be watching the data that comes out of this? I feel like this could be a big boom for “buy now, pay later” firms.
A lot of early surveys have shown that customers are increasingly interested in “buy now, pay later” options this holiday season. If you’re looking at the kind of economic environment that we’re in right now, it makes sense. The Fed’s attempts to tamp down inflation is driving up borrowing costs, and that includes credit card interest rates, which some people are estimating are now at 30 percent.
That’s putting customers in a financial catch-22. We’re increasingly being forced to use credit cards and “buy now, pay later” options to pay for the rising costs of goods and services, while borrowing that money is more expensive than ever. The way that “buy now, pay later” services advertise themselves as being interest-free and having little to no late payments, it seems pretty attractive this holiday season. Some surveys show that a lot of customers are planning to use “buy now, pay later” to buy gifts for their loved ones. I guess we’ll have to see.