“Buy now, pay later” loans are helping fuel record holiday sales. Economists worry they may be masking and exacerbating cracks in Americans’ financial health.
These loans, which allow consumers to pay for purchases in installments (often interest-free), have soared in popularity due to their high prices and interest rates. Retailers have used them to attract customers and get people to buy more.
But consumer groups and some lawmakers say these loans could encourage young and low-income Americans to take on too much debt. They can also represent a hidden source of risk to the financial system, as such loans are not regularly reported to credit bureaus or recorded in public data.
“The more we look into it, the more concerned we become,” said Wells Fargo economist Tim Quinlan, who recently published a report describing deferred loans as “phantom debt.”
Traditional indicators of consumer credit indicate that overall U.S. household finances are relatively healthy. But, Quinlan said, “that reassurance is worthless if you’re missing the fastest growing part of the market.”
Estimates of the size of this market vary widely. Quinlan believes the deferred payment option cost about $46 billion this year. This is a relatively small amount compared to the more than $3 trillion that Americans spent on credit cards last year.
However, the number of such loans offered by companies such as Klarna, Affirm, Afterpay and PayPal is rapidly increasing. The growth comes as some Americans’ finances are beginning to show early signs of strain.
Credit card debt, although not a proportion of income, is at an all-time high in dollar terms, and delinquencies are on the rise, although low by historical standards. The stress is especially pronounced among young adults.
According to the New York Fed, the biggest users of deferred loans are people in their 20s and 30s. This could be a sign of a financial problem, such as young people who may be taking out deferred loans after maxing out their credit cards, or that encouraging overspending could be a sign of It may also be the cause.
Liz Cisneros, a 23-year-old college student who works part-time at Home Depot in Chicago, said she was surprised by how easy the Pay Later program was. During her pandemic, she saw influencers on TikTok promoting loans, which her friends said helped them buy designer shoes.
Cisneros started using the service to buy clothing, shoes and beauty products from Sephora. She often took out multiple loans at once. She didn’t have enough money when she was in line at her grocery checkout, so she realized she was overspending. That morning, her postpaid company had withdrawn her funds from her bank account, leaving her unsure of her payment schedule.
“It’s easy when you’re clicking, clicking, clicking, but then it’s not,” she said of when she realized she was overusing it.
Cisneros said the problem is particularly intense around Christmas, and she didn’t shop for Christmas this year to pay off her debt.
Pay later loans have been available in the U.S. for several years, but their use began during the pandemic as online shopping surged.
These products are similar to the layaway programs that retailers offered decades ago. Online shoppers can select the pay later option at checkout or in the pay later company’s app. Loans are also available at some physical stores. Affirm announced Tuesday that it began offering pay later loans at self-checkout locations at Walmart stores.
The most common loans require buyers to pay a quarter of the purchase price upfront, with the remainder paid in three installments, usually over six weeks. These loans are usually interest-free, but users may also have to pay fees. Pay later companies make most of their revenue by charging fees to retailers.
Some financial institutions offer interest-bearing loans with repayment periods ranging from a few months to over a year.
Pay later companies claim their products are better for borrowers than credit cards or payday loans. They say that by offering shorter loans, they can better assess a borrower’s ability to repay.
“We are able to identify and expand lending to consumers who have the ability and desire to repay more than they would with a revolving account,” Michael Linford, Affirm’s chief financial officer, said in an interview.
In the most recent quarter, 2.4% of Affirm’s loans were 30 days or more past due, down from 2.7% in the same period last year. These numbers do not include loans with four payments.
Klarna chief executive Sebastian Siemiatkowski said the service makes the most sense for certain purchases, such as buying an expensive sweater that will last for years.
He said that while Klarna and other companies are making loans available at some grocery stores, pay later probably doesn’t make much sense for frequent purchases such as groceries.
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Mr. Simiyatkowski acknowledged that people could misuse his company’s loans.
“Obviously, it’s still a trust, so unfortunately you’re going to find some individuals using it in a different way than it was intended,” said Siemiatkowski, who founded Klarna in 2005. Probably.” The company identifies those users and either denies them a loan or imposes stricter terms.
Stockholm-based Klarna says the global default rate is less than 1 percent. In the US, more than a third of his customers pay off their loans early.
About four years ago, Kelsey Greco made her first pay later purchase for a mattress. It was difficult for him to pay $1,200 in cash, and it didn’t seem prudent to purchase with a credit card. So she got her 12-month interest-free loan from Affirm.
Since then, Greco, 30, has been using Affirm regularly for things like Dyson hair tools and car brakes. Although some of her loans charged interest, she said she still preferred this form of borrowing because it was clear how much she would pay and when.
“With a credit card, you can spend all day swiping cards and be like, ‘Wait a minute, what the hell did I get myself into?'” said Greco, who lives in Denver. Ta. “Whereas with Affirm, you get hard numbers that tell you, ‘Okay, this makes sense,’ or this doesn’t make sense.”
Greco, who was introduced to the Times by Affirm, said the Pay Later loan helped her avoid credit card debt, which she had previously struggled with.
But not all consumers are using pay later options judiciously.a Report from the Consumer Financial Protection Bureau This year’s survey found that about 43% of postpaid users had overdrawn their bank account in the past 12 months, compared to 17% of non-users.
“This is just a more vulnerable segment of the population,” said Stanford University researcher Ed DeHaan.
in Paper published Last year, DeHaan and three other academics found that within a month of first taking out a pay later loan, people were more likely to experience an overdraft and start accruing credit card late fees. discovered.
Financial advisers who work with low-income Americans say more and more of their clients are taking advantage of deferred loans.
Barbara L. Martinez, a Chicago financial counselor who works for the nonprofit Heartland Alliance, said many of her clients use cash advances to cover their deferred loans. Even when they receive a paycheck, it isn’t enough to cover their bills, forcing them to rely on deferred loans.
“It’s not that the product is bad,” she added. “It can quickly get out of control and cause a lot of damage that could have been prevented.”
Brianna Gaudry learned about postpaid products while in college. Because she worked part-time, she couldn’t get approved for her credit card, but her postpaid provider was eager to extend her credit. She started being late after her work hours were reduced. Eventually, her family and friends helped her pay off her debt.
Mr. Gaudley is testified about her experience He participated in a Senate hearing session last year and now works on consumer finance issues at Texas Appleseed, a progressive policy organization. She said pay later loans can be an important source of credit for communities that don’t have access to traditional loans. She still uses it from time to time to make major purchases.
But he said companies and regulators needed to make sure borrowers could afford to pay the debt they were taking on. “If you’re going to develop these products and build these systems for people, you’ve got to have some checks and balances in place as well.”
The Truth in Lending Act of 1968 requires credit card companies and other lenders to disclose interest rates and fees and provides various protections to borrowers, including the ability to dispute charges. However, the law only applies to loans with more than four installments, effectively excluding many deferred payments.
Many of these loans are not even reported to credit agencies. As a result, consumers were able to take out multiple loans with Klarna, Afterpay and Affirm without the business knowing about their other debts.
“There’s a huge blind spot right now, and we all know that,” said Liz Pagel, senior vice president of TransUnion’s consumer finance business.
TransUnion and other major credit bureaus and pay later companies have all said they support expanded reporting.
But there are also practical hurdles. Credit rating systems value borrowers with long-term loans, such as long-term credit card accounts, more highly. Each deferred purchase qualifies as a separate loan. As a result, these loans can lower a borrower’s score even if the borrower repays them on time and in full.
Pagel said TransUnion has created a new reporting system for loans. Other credit bureaus, such as Experian and his Equifax, have similar efforts.
The pay later company says it is reporting certain loans, especially those with longer terms. However, most do not report and do not commit to reporting loans after just 4 payments.
That worries economists, who say they are especially concerned about what will happen to those loans when the economy slows and workers start losing their jobs.
Marco Di Maggio, a professor at Harvard Business School who studies pay-as-you-go products, said that in tough times more people take out such loans for small expenses and end up in trouble. “He only needs one more shock to force people into default.”