A Better Approach to “Buy Now, Pay Later”

Fashion brands were among the first and most enthusiastic advocates of the “buy now, pay later” concept, which allows customers to spread payments over weeks or months. For retailers, the payment option attracted a whole new class of consumers, particularly young shoppers who didn’t have credit cards or savings.

Now the bill is due.

With inflation rising and economic growth slowing, a growing number of customers are missing payment for their clothes and makeup. Investors fear a wave of consumer defaults on these loans, especially if the economy slides into recession. In May, The Wall Street Journal reported that Klarna is targeting $1 billion in funding at a valuation of $30 billion, down a third from June 2021. Affirm shares are down about 85 percent from their November peak. Regulators are circling.

Retailers are unlikely to face the financial fallout – it’s the BNPL firms who are on the hook for those delinquent loans. However, they could see a drop in revenue if their customers stop using those services or are cut off from them as lenders tighten their standards. Brands also risk damaging their reputations, especially when consumers feel they have been misled about the consequences of borrowing money they impulsively took out just before making a purchase.

Despite recent troubles, the category seems to keep growing: Earlier this week, Apple announced that it would launch a BNPL service. When used responsibly, buy now, pay later can benefit lenders, retailers and consumers, say experts. But change is needed in this burgeoning industry: BNPL firms can reposition their installment plans to allow young and low-income consumers to build credit and better weed out those most likely to default on their loans. Retailers can do more than add a Klarna or Affirm button alongside the credit and debit card options on the checkout page; They can educate consumers about how installment payments work and be as transparent about the terms of those loans as they are about shipping costs.

“The danger is that buy-now, pay-later platforms can mask debt so consumers are unprepared to take responsibility for their financial actions,” said Cassandra Napoli, senior strategist, Insight at trend forecasting agency WGSN. “Brands have a responsibility to do what’s right for users and consumers, especially with the proliferation of ‘buy now, pay later’ services.”

change is coming

The absolute number of consumers who have defaulted on loans they bought now and paid later is still relatively small; At Affirm, 3.7 percent of loans were 30 days or more past due at the end of March. But that proportion has increased from 1.8 percent in June 2021. He could keep going up. A 2021 Credit Karma survey found that 34 percent of those who used short-term financing were late on one or more payments, while 30 percent of Gen Z customers missed two.

Rising interest rates are another problem: they raise the cost of borrowing for lenders themselves, making cheap credit more expensive for those companies to offer to buyers.

The Consumer Financial Protection Bureau, a US regulator, launched an investigation into buy-now, pay-later credit schemes in December, citing concerns about debt accumulation and data collection, among other things. The European Union, meanwhile, began tightening its oversight nearly a year ago with a proposal that would require buy-now, pay-later companies to be more transparent with consumers. Earlier this year, the UK Financial Services Authority ordered consumer credit firms to be more transparent about their terms and take other steps.

Some of the big BNPL firms make it difficult for high-risk buyers to borrow. SoftBank-backed Klarna this month began sharing payment history data from its 16 million UK customers with credit agencies, meaning their loans will appear on credit reports.

In doing so, they address one of the main accusations made by critics of installment payments: that lenders do not really know whether borrowers have the opportunity to repay them. According to Fitch Ratings, the lack of reports makes it easier for consumers to pit BNPL firms against one another, borrow from multiple lenders and default on payments while appearing to have a pristine credit history.

Linking BNPL to credit bureaus could allow a broader group of consumers to build credit histories necessary to gain access to many benefits of the financial system, said Vijay Viswanathan, associate dean of integrated marketing communications at Northwestern University’s Medill School of Journalism .

“Customers who regularly make ‘buy now, pay later’ payments should be able to build credit even if it’s not through a credit card,” Viswanathan said. “Rating agencies should work with ‘buy now, pay later’ lenders and collect this data to help segments underserved by incumbent banks and credit card companies build credit.”

Lead with education

Retailers have largely left it to the BNPL companies to educate consumers about how their loans work. For them, payment plans help shoppers buy what they want, when they want; Affirm’s retail partners are seeing cart size increase by an average of 85 percent when using their service, said Silvija Martincevic, the platform’s chief commercial officer.

But leaving it to the BNPL sector to educate consumers about credit – or not – is a mistake, said Napoli, the WGSN strategist.

“The danger is that buy-now-pay-later platforms can mask debt so consumers are unprepared to respond for their financial actions,” she said. “Brands have a responsibility to do the right thing for users and consumers.”

Napoli suggests retailers adopt financial literacy tools to help young shoppers navigate BNPL platforms and monitor their spending, with brand education materials and budget tips to share through their influencer partners.

At Afterpay, an Australian BNPL company, customers can set up budget trackers to manage when installments are due and set reminders before their scheduled payments. Nick Molnar, co-founder and co-CEO, said the company has “become a helpful budgeting tool” in and of itself. Affirms’ Martincevic said the company’s underwriting technology approves clients “only for amounts that we believe they can comfortably afford to repay.”

Viswanathan said the fundamental problem is that many buyers do not see BNPL funding as debt.

“From a financial management perspective,” Viswanathan said, “we should be aware of how smaller payments over time can impact other goals and events over the long term.”

Additionally, educating can be difficult when brands see BNPL primarily as a way to get consumers to spend more. The wide range of plans, each with their own payment plans and interest rates, can also be confusing. BNPL lenders typically don’t charge interest on smaller payments made over a few weeks, but annualized rates can be as high as 30 percent for high-volume items funded over months (the average APR for credit cards is USA at about 16 percent). federal reserve).

“When brands ethically use ‘buy now, pay later’ to do what they were designed to do, they can drive sustainable growth over the long term,” added Viswanathan. “When used unethically, they reduce themselves to loan sharks and do their customers, their communities and the economy a tremendous disservice.”