The other day I went shopping for my first big Christmas gift of the year and there it was, on the checkout page: Would I like to split this purchase into four easy, interest-free payments?
Parting with a smaller amount of money to get something you want sooner is a compelling offer. So compelling that half of all shoppers in the United States plan to use so-called “buy now, pay later,” or BNPL, services for their holiday shopping this year, according to a PayPal survey. The same survey showed that one in four millennials and members of Generation Z use payment options like Affirm and Klarna on a regular basis. These are the same young people who are struggling to find jobs, pay overdue student loan bills, and deal with rising food prices. Maybe that’s why it felt so dark when DoorDash announced a partnership with Klarna earlier this year, ushering in an era where people take out loans to pay for their takeout.
As affordability becomes the dominant issue in American politics, the holiday shopping season feels different this year. Everything is more expensive, for sure. But with everyone offering BNPL options, from fintech startups to major banks, it’s also easier than ever to finance purchases you wouldn’t otherwise be able to afford. Meanwhile, the Trump administration has removed some of the barriers to this shady lending industry, leaving consumers more vulnerable to unexpected fees and endless debt. Some even warn that the precarious situation is starting to look a lot like the early days of the subprime mortgage crisis that led to the Great Recession.
“Currently, BNPL lenders are not required to […] determine whether consumers can repay their BNPL loans,” said Nadine Chabrier, senior policy and litigation counsel at the Center for Responsible Lending. “There are currently no checks and balances for borrowers taking out multiple BNPL loans at the same time, which can lead to overextension.”
if you have seen The big short or just follow the development of the story, this sounds quite worrying. However, before I get carried away with warnings about an impending economic crisis, let’s review how these small loans work.
Buy now, pay later, hurt forever.
In the early days of the industry, you would most likely find a BNPL option on the checkout page of an e-commerce website, probably one that sold luxury goods. The option to pay in installments, often interest-free, made it easier for consumers to pull the trigger on high-priced items, so stores quickly adopted the feature. Lenders would make money by taking a small portion of the purchase price and would also charge the consumer fees for late payments.
Venture-backed fintech startups led the charge. Affirm, founded in 2012, helped bring BNPL mainstream and Klarna joined the market in 2015. The pandemic supercharged the industry and the dollar amount lent soared from $16.8 million in 2019 to $180 million in 2022, according to a Consumer Financial Protection Bureau (CFPB) report released that year. The average loan at the time was $135.
A big problem, as Chabrier pointed out, is that BNPL lenders generally don’t have to check whether you can afford to take out a loan, and it’s possible to take out several at once, a practice known as “loan stacking.” These factors could explain why late payments are so common. More than 40 percent of BNPL users say they made a late payment last year, up from 34 percent last year, according to a Lending Tree survey. Meanwhile, more than 20 per cent say they have had three or more loans at once, and a quarter of people surveyed said they have taken out a BNPL loan to buy food.
This is a good time to highlight the fact that not all of these loans are interest-free. Both Affirm and Klarna say their interest rates can go as high as 36 percent (Klarna’s actually top out at 35.99 percent, but it’s fair to round up). That’s still much lower than payday loans, which can be as high as 600 percent, but it’s much higher than zero.
Let us now return to the looming financial crisis. Until very recently, most BNPL loans were not reported to the credit bureaus, which meant there was very little visibility into who was borrowing and at what rates. During the Biden administration, the CFPB attempted to regulate the industry by issuing a rule that would treat BNPL lenders like credit card companies, but the Trump administration rescinded that rule earlier this year. Around the same time, the company that makes the FICO score, a measure of how likely someone is to repay a loan, said it would introduce a new type of score that would take into account BNPL debt. Currently, those scores can only be seen by lenders, but not consumers.
The BNPL industry remains largely unregulated at the national level. Meanwhile, all that consumer debt is becoming a financial product in itself. Elliott Investment Management just reached a deal to buy $6.5 billion worth of Klarna debt, as the fintech company expands its business into larger, longer-term loans for consumers. Affirm had sold nearly $12 billion in securitized debt as of June.
In a recent TechCrunch article, Connie Loizos explained what BNPL companies are doing in bleak terms: “Reduce risky consumer debt, sell it to investors who believe they understand the risk profile, and create layers of financial engineering that obscure where the real exposure lies.”
Again, this sounds a lot like the subprime mortgage crisis. However, it is not clear whether we should use such big words for what is happening right now.
“It would be premature to say there is a crisis,” Chabrier told me. “While it is possible, we don’t know enough about the extent of BNPL lending to say such a thing.”
What we can say, on an individual level, is that BNPL is becoming more dangerous. The industry “has built a delusional new consumer culture and trapped users in a vortex of debt,” according to a New York Times Magazine article about people who just started shopping, didn’t read the fine print, and got into real trouble.
As this holiday shopping season begins, read the fine print. Or better yet, don’t buy now and pay later. The American economy may thank you.
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