For the past 60 years, Americans have been impacted by the vicious cycle of credit cards. Now there is a new kid on the block.
“Buy Now, Pay Later” (“BNPL”) has taken the personal finance arena by storm. The number of Americans who have used the lending model, which is highly popular in Australia, has increased 300% every year since 2018, according to Bloomberg.
BNPL companies like Afterpay, Klarna and Affirm claim that the model is financially inclusive to people who can’t access traditional forms of credit. Consumer Finance Advocates argue the model is under-regulated and poses risks to consumers. If this sector continues to grow, it could put a generation of younger Americans into a debt trap.
BNPL splits purchases into multiple interest-free payments and is often used by consumers who are not creditworthy. While the sector’s various companies may differ slightly, BNPL services allow a consumer to pay for an item or service in four interest-free installments over a period of time.
While BNPL started picking up steam before COVID-19, a pandemic-related shift in consumer spending to e-commerce and retail goods fueled the sector’s growth. Several tech and financial services companies are also jumping on the bandwagon. In June, Apple became the latest major player to announce its own BNPL service.
BNPL services generally don’t charge interest like credit cards, but they do charge fees or other penalties when users miss a payment. Late payments may even trigger overdraft fees in a buyer’s bank account. If these hidden costs were translated into an interest expense, the cost could easily exceed State usury rates.
Unlike credit cards, it can be difficult to track what exactly is owed. If users take out multiple BNPL loans at once, they can quickly get themselves into trouble. In general, many consumers appear to be confused by BNPL. One survey found about a third of BNPL users don’t understand the service well.
Part of the reason consumer debt traps are even possible is that BNPL services are mostly unregulated Consumers have numerous protections against traditional lenders, like credit card companies, under the Truth in Lending Act (TILA). But BNPL lenders are able to skirt TILA because the law only covers loans that are split into five payments or more. BNPL stops short at a split of four payments.
Skirting TILA means BNPL companies have less legal responsibility to make sure users can pay back the loan. Some services may do mild credit checks for big-ticket items, but for the most part loans are handed out with no questions asked. Further, while certain BNPL services may ban users until their debt is paid, those consumers are not prevented from taking out loans at other BNPL companies.
BNPL companies position the product based upon the ease with which consumers can use their products as a substitute for those barred from traditional credit. Meanwhile, a recent study found that nearly one-fifth of BNPL customers only used the service after maxing out their credit card.
The bottom line take away is that BNPLs are nothing more than a repackaged finance company scheme similar to that your grandparents may have used in the 1940s, 1950s and 1960s to finance major purchases. The difference now is that the companies do not care about the recovering the goods, just collecting exorbitant fees.