(ATF) Buy Now, Pay Later (BNPL) financing that US retailers have increasingly deployed to tempt shoppers during the pandemic may be booming in popularity – but to the dismay of many American shoppers like Leondra Garrett, it can also come with pitfalls.
Worse, it can even lead one into a debt trap.
When Leondra Garrett wanted to stock up on three new pairs of shoes early last year, the North Carolina resident split a $161 online purchase into four installments through a "buy now, pay later" service, in what seemed like a convenient deal.
Now, she admits she should have read the small print about missed payments.
When the BNPL provider tried to withdraw a payment from Garrett's bank account a few months later, she didn't have enough funds to cover it. Soon, the 42-year-old was charged $40 in penalties and her credit score dropped 10 points to 650, a reading generally classified as 'fair'.
"It's important for consumers to always read the fine print and we don't always do it," said Garrett, a community organizer from Charlotte.
Like Garett, nearly 40% of US consumers who used "buy now, pay later" have missed more than one payment, and 72% of those saw their credit score decline, according to a study by Credit Karma, which offers customers credit score checking for free.
"The percentage of consumers missing payments is remarkable and not as low as you would expect," said Gannesh Bharadhwaj, general manager for credit cards at Credit Karma.
"When you make something so convenient, people may not be really thinking, 'Do I have the budget? Can I afford this payment?' You get more of that impulse-shopping behaviour that leads to realizing they may not be able to make the payment," Bharadhwaj added.
A lower credit score signals to lenders that a consumer may be higher risk and makes it harder for the consumer to borrow, whether to secure a mortgage or a new credit card. It can even make it more difficult for a consumer to set up utility accounts or find housing, as landlords will generally conduct credit score checks before renting out apartments.
Still, shoppers are drawn to BNPL because the scheme allows them avoid having to pay credit-card transaction fees, which run about 2% to 3% per transaction.
Nearly half of the consumers that use BNPL, according to a CNBC report, said that it is somewhat or very important in determining how much they spend during the holidays.
Further, 48% said BNPL allows them to spend at least 10% to 20% more than they would using a credit card
But, half of 6,500 adults recently surveyed by Cardify.ai, a data firm that tracks consumer spending, are also concerned that it will cause them to overspend.
Management consultants Oliver Wyman estimate BNPL facilitated between $20 billion-25 billion in transactions in the US last year, although analyst estimates on the size of the BNPL industry vary because it is relatively new and some of the companies are private.
Individually, they described explosive growth last year as their services became more prevalent.
For instance, since October last year, retailers from Gap, GameStop, Macy’s and Neiman Marcus, with their respective fintech app partners in the field, have rolled out the so-called BNPL alternative payment option at checkout online with some also enabling the service for in-store shopping.
They followed other retailers including retail giant Walmart, which last year introduced what it described as “alternative to layaway” through Affirm.
BNPL is attractive to retailers because they tend to get upfront payment from BNPL platforms faster than they would from credit-card transactions, said Ted Rossman, an industry analyst at Bankrate.
BNPL models vary, with some companies earning most profits by collecting fees from merchants at the point of sale, and others charging interest and late fees to consumers. They say their services help merchants to boost sales and consumers to buy things they need, and cause less financial damage than credit cards because of restrictions they impose.
The provider platform to grab a share of the $25bn BNPL-market pie in the US is getting crowded too
In terms of US users though, while PayPal Credit has far more users than its competitors, others are closing in.
San Francisco-based Affirm saw its revenue rise 93%, to $509.5 million, in the fiscal year that ended in June. It allows shoppers to split up purchases in terms ranging from six weeks to four years, with interest rates of 0 to 30%.
Sweden-based Klarna saw fast growth over the past year, especially purchases in the $100-$200 range, said its US head, David Sykes. Customers can delay one payment without a penalty. Late fees vary by state in line with regulation, up to a maximum of $21 and the company is rolling out a 25% cap.
AFTERPAY'S US MOVE
For Australia's Afterpay, which entered the US market just over two and a half years ago, the total number of customers who have signed up with the platform has topped 13 million, including 5.6 million active users with an average age of 33, the company said.
The services are friendly as well.
Affirm, for instance, shows customers how much a loan will cost in dollar terms and does not charge late fees or compound interest. Although missed payments can affect credit scores, Affirm says it has been working with borrowers who fell on hard times during the pandemic.
PayPal 'Pay in 4' service, launched widely across the US in November, allows customers to split purchases ranging from $30 to $600 in four interest-free payments. Late fees may apply for missed payments, depending on the user's state of residency, according to its website.
The company says 95% of its transactions globally are paid back on time and late fees contribute less than 14% of the company's total income.
Nonetheless, regulators in Britain and Australia are reviewing or tightening rules around the industry. BNPL service providers, classified as fintech companies, should be subject to stricter rules more like banks, some regulators say.
The UK regulator, Financial Conduct Authority for instance, estimates 5 million people have used this option to buy on credit during the pandemic, yet some of the key providers — such as Klarna and Clearpay — currently fall outside of the scope of FCA regulation.
The watchdog is now working with the Treasury to draw up new legislation that will bring them in, following an urgent recommendation in the report drawn up by former FCA interim chief executive Christopher Woolard.
Policymakers, some of whom called the industry “the next Wonga” — a reference to what was once the UK’s largest pay-lending sharks, could demand tougher credit checks due to the “lack of visibility” around BNPL debts.
It is unclear how buy now, pay later fits into US regulations because the companies that offer these services do not have bank charters, some do not charge interest and laws vary by state.
However, some experts expect the sector to come under more scrutiny during the Biden administration.
"One of the questions with the new administration is, what stance will the Consumer Financial Protection Bureau take going forward – which we expect to be more aggressive," said Mark Palmer, financials analyst at BTIG Research.
BNPL providers have been quick to welcome the prospect of a new regulatory regime, while maintaining that customers should not be stopped from accessing flexible payment options that provide an alternative to long-term debts.
"We are working with the industry and the consumer credit bureaus to develop the appropriate framework," said Greg Lisiewski, PayPal's global vice president of Global Pay Later
The PayPal 'Pay in 4' product in the United States does not report trades or late fees to the credit bureaus.
Most of Klarna's loans are small, of short duration and interest-free, which is safer for customers than credit cards, he said. "No one is getting buried in debt with Klarna," Sykes said. "We aren't making multi-year loans on a car or a house."
Smaller loans with shorter durations do have benefits, but they are not risk-free, experts said. Customers may be taking on more debt than they can handle, even if it comes in bite-sized portions.
Tamika Rivera, a 35-year-old insurance agent from Springfield, Massachusetts, uses multiple buy now, pay later services, and has missed payments. In one case, she did not have enough money to cover a $43 sweater purchase, which resulted in a $35 overdraft fee from her bank.
"These services are convenient but there are some negative things that can happen," Rivera said.
For 40% of America’s millennials though, with no access to traditional credit - either because they've maxed out their credit limit or because of a poor or non-existent credit history - BNPL may be the only option for some easy shopping, say some.
- With reporting by Reuters.
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