As “buy now, pay later” plans increase, so do arrears

NEW YORK — Americans love “buy now, pay later” services, but the “pay later” part is becoming increasingly difficult for some borrowers.

Buy now, pay later Loans allow users to pay for items such as new sneakers, electronics or luxury goods in installments. Companies like Affirm, Afterpay, Klarna and PayPal have developed popular financial products around these short-term loans, especially for younger borrowers who fear endless credit card debt.

Now that the industry is accumulating customers, arrears are rising. Inflation depresses consumers and makes it harder to pay off debt. Some borrowers do not budget properly, especially when persuaded to take out multiple loans, while others may have taken credit risks from the start.

“You have an industry with a higher concentration of subprime borrowers in a market that hasn’t been effectively tested (that kind of economy), and you have kind of a toxic brew of concerns,” said Michael Taiano, an analyst at Fitch Ratings. who co-authored a report in July highlighting some of the industry’s concerns.

The most popular type of buy-now-pay-later loan allows for four payments over six weeks — one payment at the time of purchase and three others that borrowers often try to sync with payment periods. Longer-term loans for larger purchases are also possible. Most short-term loans are interest-free. Companies that charge interest can clearly indicate up front how much a borrower will pay in financing costs.

Given these characteristics, consumer advocates and financial advisors initially saw “buy now, pay later” plans as a potentially healthier form of consumer debt if used properly. The biggest concern was late fees, which for a small purchase could represent a large financing fee if a borrower defaults on a payment. Fees can be as high as $34 plus interest. But now, as defaults rise and companies are more aggressive in marketing their products, proponents see a need for additional regulation.

The industry is experiencing growth rates not typical of financial services. Klarna’s customers bought $41 billion worth of products worldwide through its service in the first six months of the year. 21% more than a year ago. PayPal’s revenue from its Buy Now, Pay Later services more than tripled to $4.9 billion in the second quarter.

Jasmine Francis, 29, a technology analyst from Charlotte, North Carolina, said she first used a buy-now-pay-later service to buy clothes from fast-fashion brand Forever21 in 2018.

“I remember just having a cart full,” she said. “At first I thought, ‘Something needs to go back’, and then I saw Afterpay at the checkout – you don’t pay for everything now, but you get it right away. That was music to my ears.”

It is unclear how healthy customers are in using “buy now, pay later” loans. Fitch noted that arrears at these services rose sharply in the 12 months ended March 31, while arrears at credit cards were flat — although arrears at AfterPay, which focuses primarily on short-term loans, declined slightly over the past two quarters were.

Credit reporting firm TransUnion found that borrowers use buy-now, pay-later plans even though they also accumulate credit card debt. A Morning Consult survey released this week found that 15% of “buy now, pay later” customers use the service for routine purchases like groceries and gas, a behavior that’s raising alarms among financial advisors.

“If these ‘buy now, pay later’ plans are not budgeted appropriately, they can have repercussions throughout a person’s financial life,” said Andre Jean-Pierre, a former Morgan Stanley wealth advisor who now runs his own financial planning firm to help black Americans save and budget appropriately.

Another concern of advisors and consumer advocates, as well as lawmakers and regulators in Washington, is the ease with which consumers can top up these installment loans.

At a Senate Banking Committee hearing Tuesday on new financial products, Sen. Sherrod Brown, D-Ohio, touted the benefits of plans that allow consumers to pay for things in installments. But he also criticized the way the industry is pushing the plans.

“Ads encourage consumers to use these plans to make multiple purchases across multiple online stores — and accumulate debt they can’t afford to pay back,” Brown said.

The short-term loans may be problematic as they are not reported on a consumer credit profile at Transunion and Experian. Additionally, the industry’s buy-now, pay-later customers are young — which means they have little credit history to begin with. Hypothetically, a borrower could take out multiple short-term loans through multiple companies, pay later — a practice known as “loan stacking” — and they would never show up on a credit report. If a person puts too many items on “buy now, pay later” plans, budgeting could be difficult.

“It’s a blind spot for the industry,” Fitch’s Taiano said.

The industry and trade group Buy Now, Pay Later pushed back on the characterization that its products could leave borrowers with too much debt.

“With zero to low interest rates, flexible payment terms and transparent terms and conditions, BNPL helps consumers responsibly manage their cash flow and live healthier financial lives,” said Penny Lee, CEO of the Financial Technology Association, in a statement.

The Consumer Financial Protection Bureau is studying the popularity of buy-now-pay-later loans and is expected to release a report with its findings soon.

Francis, the technology analyst, said it’s now common among her friends to use installment loans to pay for trips so they don’t drain their bank accounts completely in an emergency.

“If I come home from vacation and I have two flat tires and I’ve spent all that money on plane tickets, that’s $400 that you don’t have right now,” she said. “Most people don’t have any savings. They have just enough for these flat tires.”

Meanwhile, providers of “buy now, pay later” services see rising defaults as a natural consequence of growth, but also as an indication that inflation is most likely to hit Americans, who will use these services the hardest.

“I wouldn’t call it some sort of harbinger of a possible downturn, but it’s not the same kind of smooth sailing it used to be,” said Max Levchin, founder and CEO of Affirm, one of the largest buy-now, pay-later companies. Levchin said Affirm takes a more conservative approach to lending.

Despite the concerns, the consensus is: buy now, pay later. Businesses are here to stay. Affirm, Klarna, Afterpay, which is owned by Block Inc., as well as PayPal and others are now widely embedded in e-commerce.

In addition, the growth of the industry attracts more players. Tech titan Apple earlier this summer announced Apple Pay Later, which allows users to put purchases on a four-payment plan over a six-week period.

“I generally schedule purchases I make with PayPal using ‘Pay in 4’ so that my purchase due dates end up on my payment dates since the due dates are every other week,” said Desiree Moore, 35, of Georgia.

Moore said she tries to use “buy now, pay later” plans to cover purchases that aren’t in her usual monthly budget so as not to take money away from her children’s needs. She has increasingly used the plans as inflation has made items more expensive and so far has been able to keep up with the payments.

Buy now, pay later in the US after the Great Recession. The product, analysts said, was largely not tested during a major period of financial hardship, unlike mortgages, credit cards or car loans. Even finance executives have recognized the new challenges facing the industry.

“We’ve seen some strains (among those with the lowest credit scores) and they’re starting to have a hard time,” Levchin said.

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AP Personal Finance reporter Cora Lewis contributed to this report from New York.

Virginia C. Taylor