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'Buy now, pay later' options start to trend as a popular but risky credit darling

Experts say some millennials find themselves in a spending cycle that’s hard to manage

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Once again, a new shopping wrinkle enhanced by COVID-19 is starting to trend upward. Quietly, but steadily, “buy now, pay later” (BNPL) services are starting to gain favor with consumers. While it can be a helpful option, financial analysts are worried that some consumers may be misusing BNPL to buy unnecessary or luxury items that they otherwise wouldn't be able to afford. 

The concept of BNPL has been around for a while, but the crunch that the pandemic has put on people’s wallets and shopping behaviors is leading to exponential growth. For those who lost their jobs, it reduced the stress of buying essentials or replacing an appliance that went haywire. And for consumers nervous about the health risks of shopping in-store, it gave them another reason to do their shopping online.

How BNPL works

The basic idea behind BNPL is straightforward. Older consumers may define it as nothing more than “90-days-same-as-cash,” and in essence, it is similar. The difference is that we’re in the 21st century now, and BNPL caters to today’s nuances via an app-based, interest-free loan that shows up as a payment option at the checkout page of online retailers. 

All BNPL customers pre-qualify for a certain amount that is determined by the service that they're using. As an example, BNPL service Affirm says that its pre-qualified amount is “an estimate of what a lender may qualify you to borrow in the future.” That's different from a credit limit, which is “the maximum amount of credit a lender has already decided you can borrow.”

While those basics sound fairly simple, less than one-fourth of the people who use BNPL say they understand all of the terms and conditions. And if a consumer doesn’t pay attention to them, it can be a big problem.

The first point of confusion is BNPL companies’ use of the term “interest-free” for promotions. In BNPL land, “interest-free” only works for a set period of time. 

“If you pay off your balance before the period ends, you can avoid paying interest altogether. The regular interest rates on BNPL are typically very high,” The Ascent’s Elizabeth Aldrich explains.

“For example, if you're making a $200 purchase, you might see a BNPL payment option that lets you pay for the item in four interest-free installments of $50 each. You'll pay $50 today and receive your item, then another $50 every two weeks for six more weeks. If you don't make your payments on time or fail to pay off your balance before the interest-free period ends, you could get hit with big late fees and interest charges,” Aldrich said. 

The floodgates have opened

The love for BNPL really took off over the 2020 holiday season, particularly with sales of electronics and other items consumers might not otherwise be able to afford. In response, online retailers jumped on board in droves to capitalize on this new normal of retail

Now, only months later, the BNPL floodgates have opened. The A-Z list of BNPL retailers includes notables from Amazon to Zulily. 

The embrace of BNPL is also starting to expand past retail. Uplift -- a buy now, pay later solution for the travel industry -- is seeing an uptick in demand for flexible payment options. The service thinks BNPL could be the economic kickstarter that’s needed to reignite the pandemic-torn travel industry.

As you might imagine, the app side of the equation is licking its chops over the newfound bonanza. There are close to 10 serious players in the app marketplace already, and Bank of America expects that number will “grow 10-15x by 2025 to eventually process $650bn-$1tn in transactions.” 

The BNPL company most consumers are aware of is probably PayPal Credit (formerly known as Bill Me Later). Others include Affirm, Klarna, Sezzle, Afterpay, Splitit, Quadpay, ViaBill, Zebit, and Perpay.

Clever or risky?

One analyst called BNPL a “mass experiment” and said the fallout could be painful for consumers and lenders alike. 

“Is BNPL a clever way for younger borrowers to take on sensible credit, or did lenders just give billions of dollars of loans to a bunch of subprime borrowers in the checkout aisle?,” pondered Alan McIntyre, senior managing director and head of the global Banking practice at Accenture.

“The answer matters. Investors love that the fintech firms doing the lending — Klarna, Affirm, Afterpay and others — are disrupting the traditional credit card business. Consumers, not known for restraint, love being offered a 0 percent line of credit without a complicated application process,” McIntyre said.

Credit reporting bureaus are also warning consumers that BNPL is no different than any other form of credit. However, it can have a serious impact on credit scores depending on how it’s used. Just ask the two million shoppers in the U.K. who damaged their credit scores using "buy now, pay later” services.

Retailers have fallen in love with BNPL

For their part, retailers appear to be on board with the BNPL trend. Reports suggest that BNPL users make larger purchases and leave fewer online shopping carts abandoned. As a bonus, retailers aren’t on the hook for collecting because that responsibility lies with the BNPL service. 

The only thing the retailer loses is a small percentage of the purchase price -- which can run anywhere from 2 to 8 percent. That rate may be higher than a typical credit card discount rate, but unlike credit cards, the BNPL provider is the one carrying the risk of fraud and chargebacks, not the retailer. That means the merchant gets their money no matter what, even if the transaction is fraudulent.

The millennial play

While BNPL isn’t generationally-exclusive, millennials appear to be drawn to its flame more than other demographics, and the service providers are playing to that strength. 

When the company behind BNPL app Affirm filed for an IPO with the Securities and Exchange Commission (SEC), it made no bones about the “spending power of this new generation of consumers.” 

“Most importantly, we believe these consumers are also increasingly looking to solutions like ‘buy now, pay later’ as superior, more transparent payment options that match their demand for technology and mobile-first solutions,” Affirm Holdings, Inc. noted in its filing.

For some millennials, BNPL is a gift from the financial gods. It caters to those who want to make purchases that they couldn’t otherwise fit into their budget and those who want to borrow money without a credit check. However, it also works out for shopaholics who can order the same item in different sizes or colors and send back the ones they don’t like. 

“Shop now and pay over time is appealing to a generation who appeared to be risk-averse, but who values newness, [a] testament to their social media accounts filled with posts of novel fashion looks, often daily. For cash-strapped millennials or those who don’t have credit cards, pay later services sound enticing,” suggests FashionUnited’s Don-Alvin Adegeest. 

But, BNPL may be driving young consumers to spend more than they can realistically afford. One young Brit earning close to $40,000 U.S. a year told the DailyMail that she is struggling to control her finances and shopping habits because of BNPL offerings.

“My spending’s gone up drastically since I’ve been using buy now, pay later,” said Yasmine Ibrahin. “It becomes a vicious cycle. You use it once and, then, you have to use [it] the next time because the money for the last thing you bought has just come out of your account.”

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