Buy now, pay later brought another credit option to stressed budgets, with a model that typically settles an installment loan in four consecutive monthly payments. With a relatively low threshold for credit underwriting, BNPL has become a significant lending vehicle.
The Federal Reserve estimates the market at $160 billion per year, according to the New York Times.
But an easy path into credit is not necessarily an easy way out of debt. The BNPL model has been criticized in jurisdictions ranging from Australia to the United Kingdom and the U.S. for a lack of transparency and for business models that can generate additional revenue through late fees and other charges. Even in the home market of top provider Klarna, the company has faced regulatory scrutiny, as we discussed in our research report, Klarna Gets Its Wrist Slapped Again: BNPL Brings Volume, but Not Credit Quality or Profits.
In the Netherlands, Kifid, the Financial Services Complaints Institute, has also raised concerns about Klarna’s practices, including whether consumers have adequate safeguards to ensure they can meet their credit obligations.
Shifting from Durable Expenses to Everyday Obligations
The Times reports that “The lending apps Flex and Zip allow customers to take out loans to pay for their broadband, electricity, health insurance, mobile phone service, mortgage and water bills. Affirm, one of the most popular pay-later apps, has started providing some tenants loans to extend their monthly rent payment for a few weeks.”
That’s where BNPL gets scary.
It is one thing to finance a marginal borrower with a 600 FICO score, which classifies the borrower as subprime, because a $100 purchase can be paid off over eight weeks in four installments. But when financing expands to utilities, insurance, rent and other essential expenses, the product starts to look less like short-term installment lending and more like payday lending.
Low-Grade Lending Creates a Consumer Trap
BNPL is an interesting consumer collateral class, but it has a purpose: extend credit to qualified consumers who want to make a purchase without putting it on a credit card. That’s not necessarily a bad thing.
But when you open up financing to people who need to cover everyday responsibilities, like paying rent or water bills, a looming problem emerges. Some consumers may need a little help now and then. But boxing your way out of a financial gap when you are not meeting the monthly budget becomes an issue.
For consumers with little or no savings, BNPL can become one of the few readily available options. But once BNPL moves into the payday-loan category of consumer perception and risk, pricing will inevitably have to evolve to cover credit losses.
Payday Lending in Florida: 214.02%
To support a high-risk lending model, lenders need higher rates than traditional credit card lenders. Default rates can be significantly higher, the lender must fund the loans directly, and there are fewer opportunities to cross-sell other financial products. A credit card relationship, for example, can lead to auto loans, personal loans, and other products. But in this space, margins must be high to ensure the lender makes a profit.
For a $600 payday loan in Florida, a borrower can pay an additional $188.82 over an 85-day loan. And Florida does not carry the highest potential cost. In Missouri, the legal limit is substantially higher (1,950%), while in states like Idaho and Texas, where payday-lending restrictions are less stringent, there is no maximum legal rate, according to Pew Research.
BNPL Is a Good Thing, Don’t Taint it with Everyday Expenses
BNPL opens a lending channel for many consumers. Who hasn’t found a great item on Amazon that is worth the loan?
But when you move the option into daily living expenses, you are bound for a pricing change, and worse than that, you end up with something similar to “perma-debt,” a ghost from the Great Recession.
