Buy now, pay later models are gaining popularity. What are the risks?
The rapid growth among players in the buy now, pay later space has caught the attention of a federal agency focused on consumer protection.
The Consumer Financial Protection Bureau launched an inquiry into buy now, pay later credit late last year. A new survey from the bureau found buy now, pay later loans have been taking off in recent years: There were 180 million loans worth $24 billion among just five firms in 2021, almost a tenfold increase from 2019.
And much like the mortgage industry before 2008, buy now, pay later loans are offering credit to borrowers who may not be considered loan-worthy. A 2021 report from TransUnion found that 69% of buy now, pay later users are considered subprime or near prime.
Interest-free credit is especially appealing to young shoppers and people with a lower income because it allows them to purchase a product and pay back the loan over four installments. Most loans range from $50 to $1,000, according to CFPB.
But not everyone who signs up for a loan is able to pay it off on time. The bureau found about 1 in 10 buy now, pay later users last year were charged at least one late fee. Another recent report from management consulting firm cg42 found nearly 40% of those users regularly have to pay late fees.
"(The) same features that make BNPL popular" – such as its lack of interest and ease of access – "may present risks to borrowers’ short- and long-term financial health," the CFPB report reads.
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The report cites data that suggests consumers might be spending more than they otherwise would through buy now, pay later.
And with the Federal Reserve hiking interest rates each month, these loans could become even more attractive, which has led some experts to say its growth is bad news for borrowers.
What is the risk of buy now, pay later?
The CFPB outlined a number of concerns with buy now, pay later in its report, noting more borrowers seem unable to pay off their loans.
Nearly 11% of borrowers last year were charged at least one late fee compared with 7.8% the year prior.
Many lenders tend to charge around $7 per missed payment on an average loan size of $135, according to CFPB. Several lenders waive late fees on request and not all late fees charged are collected.
The bureau listed several potential consumer risks in its report, saying buy now, pay later products often lack clear disclosures of loan terms; may compromise consumers’ privacy through data harvesting; and may encourage overextension.
"(More) people are using it to supplement their weekly spend on things like groceries," said Hugh Tallents, senior partner at management consulting firm cg42. "If that becomes habitual, particularly for young people, it's going to become even more commonplace to spend money that you haven't earned and have no guarantee of earning."
That could be bad news for borrowers, especially as growing interest rates risk sending the U.S. into recession.
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A 2021 Credit Karma survey found about one-third of buy now, pay later consumers fell behind on at least one payment. Of those shoppers, 72% believed their credit score declined as a result.
“I’m a strong believer that there’s no free lunch,” said Robert Lawless, a law professor at the University of Illinois. “If it seems too good to be true, it probably is.”
But others, like Mizuho analyst Dan Dolev, believe the risks to buy now, pay later loans are “much less dramatic" than recent commentary makes it out to be.
Dolev said there are shoppers who may misuse the system but firms should eventually be able to use the data to sort out these users.
“I think eventually you'll get a natural process of elimination, where some of those bad apples are going to be filtered out of all the systems and then you'll get a cohort of borrowers – that’s the hope – who are responsible,” he said.
Is buy now, pay later similar to subprime loans made during the Great Recession?
The buy now, pay later model does share "strong parallels" to the pre-2008 mortgage industry that helped trigger the Great Recession, according to Wesley Yin, an associate professor of economics at the University of California, Los Angeles who served in the Obama administration.
He pointed to borrowers in both cases being unclear about the terms of the loans. In the mid-aughts, it was borrowers with interest-only adjustable-rate mortgages who were unaware that their monthly payments would escalate. With buy now, pay later, shoppers may not be aware of the downfalls of missing a payment.
"Yes, I can read the fine print, but it might not be really clear," Yin said. "I think there's a lot of consumer protections that need to be considered in those cases."
Buy now, pay later also offers credit to borrowers considered subprime, much like the mortgage industry did in the years leading up to the Great Recession.
"I don't think it's definitely a bad thing, because we need to have avenues for people to get access to credit," said Cliff Robb, a consumer science professor at the University of Wisconsin-Madison. But some borrowers may struggle with buy now, pay later "because they may have over-projected their ability to manage it."
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While there are similarities, does buy now, pay later have the potential to trigger a recession like the subprime mortgage crisis of 2008?
“There are similarities in the consumer experience when it comes to the purchase decisions,” Yin said. “But in terms of its macroeconomic implications, (it’s) probably less worrisome.”
For one, Yin pointed out that no one is using the sofa or sneakers they purchased with a buy now, pay later loan as the basis of a refinance or second mortgage.
Buy now, pay later debt is also small compared to other sectors. A report from cg42 expects outstanding buy now, pay later debt to be $15 billion by 2025, a fraction of the $890 billion Americans hold in credit card debt or $1.7 trillion in student loan debt.
“It’s not unimportant,” Robb said. “But it’s not the same magnitude as what we saw with the subprime crisis. I don't think it's also likely that we'd see the same type of collapse.”
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Nevertheless, buy now, pay later debt could impact the economy at large.
Data from CFPB found about half of buy now, pay later users are under 33. If those young spenders find themselves unable to pay off their debt in a downturn, it could be “really problematic,” according to Robb.
“It could be a significant percentage of young Americans that are in a hole that harms overall productivity and growth,” he said. “Bottom line is we want young consumers to be able to build strong foundations for the future of the economy.”
Yin also noted that the growing popularity of buy now, pay later may be a symptom of a deeper problem in the economy versus a problem itself.
“Is it a luxury to want an iPhone, or is it a luxury to want a new sofa?” he said. “The fact that people can't pay for it, I think is the issue.”
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