NEW YORK (AP) — Americans have grown fond of "buy now, pay later" services, but the "pay later" part is becoming increasingly difficult for some borrowers.
Buy now, pay later loans allow users to pay for items such new sneakers, electronics, or luxury goods in installments. Companies such as Affirm, Afterpay, Klarna and PayPal have built popular financial products around these short-term loans, particularly for younger borrowers, who are fearful of never-ending credit card debt.
Keep scrolling for a Q&A on what you should know about "buy now, pay later"
Now, as the industry racks up customers, delinquencies are climbing. Inflation is squeezing consumers, making it tougher to pay off debts. Some borrowers don't budget properly, particularly if they are persuaded to take out multiple loans, while others may have been credit risks to begin with.
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"You have an industry with a higher concentration of subprime borrowers in a market that hasn't been effectively tested through (this type of economy), and you have a kind of a toxic brew of concerns," said Michael Taiano, an analyst with Fitch Ratings, who co-wrote a report in July highlighting some of the concerns with the industry.
The most popular type of buy now, pay later loans allow for four payments over six weeks — one payment at the time of purchase and three others that borrowers often try to sync up with pay periods. Longer-term loans for bigger purchases are also available. Most of the short-term loans have no interest attached to them. Companies that do charge interest can clearly state upfront how much a borrower will pay in financial charges.
Given those features, consumer advocates and financial advisors initially had seen buy now, pay later plans as a potentially healthier form of consumer debt if used correctly. The biggest concern had been late fees, which could act as a hefty finance charge on a small purchase if a borrower is late on a payment. The fees can run as high as $34, plus interest. But now as delinquencies are rising, and companies are being more aggressive in marketing their products, advocates see a need for additional regulation.
The industry is growing rapidly, according to a report released Thursday by the Consumer Financial Protection Bureau. Americans took out roughly $24.2 billion in loans on buy now, pay later programs in 2021, up from only $2 billion in 2019. That industry-wide figure is only expected to jump even more. Klarna's customers bought $41 billion worth of product on its service globally in the first six months of the year, up 21% from a year ago. At PayPal, revenue from its buy now, pay later services more than tripled in the second quarter to $4.9 billion. Read the full story here:
Explainer: What to know about 'buy now, pay later'
Q: How does buy now, pay later work?
Answer: Branded as “interest-free loans,” buy now, pay later services require you to download an app, link a bank account or debit or credit card, and sign up to pay in weekly or monthly installments. Some companies, such as Klarna and Afterpay, do soft credit checks, which aren't reported to credit bureaus, before approving borrowers. Most are approved in minutes. Scheduled payments are then automatically deducted from your account or charged to your card.
The services generally don't charge you more than you would have paid up front, meaning there's technically no interest, so long as you make the payments on time.
But if you pay late, you may be subject to a flat fee or a fee calculated as a percentage of the total you owe. These can run as high as $34 plus interest. If you miss multiple payments, you may be shut out from using the service in the future, and the delinquency could hurt your credit score.
Q: Are my purchases protected?
Answer: In the U.S., buy now, pay later services are not currently covered by the Truth in Lending Act, which regulates credit cards and other types of loans (those paid back in more than four installments).
That means you could find it more difficult to settle disputes with merchants, return items, or get your money back in cases of fraud. Companies can offer protections, but they don't have to.
Lauren Saunders, associate director at the National Consumer Law Center, advises borrowers to avoid linking a credit card to buy now, pay later apps whenever possible. If you do, you lose the protections you get from using the credit card while also opening yourself to owing interest to the card company.
“Use the credit card directly and get those protections,” she said. “Otherwise, it’s the worst of both worlds.”
Q: What are the other risks?
Answer: Because there's no centralized reporting of buy now, pay later purchases, those debts won't necessarily appear on your credit profile with major credit rating agencies.
That means more companies may let you buy more items, even if you can't afford them, because the lenders don't know how many loans you have set up with other companies.
Payments you make on time aren't reported to credit rating agencies, but missed payments are.
“Right now, buy now, pay later can’t generally help you build credit, but it can hurt,” said Saunders.
Elyse Hicks, consumer policy counsel at Americans for Financial Reform, a progressive nonprofit, said people may not consider seriously enough whether they'll still be able to afford payments down the road.
“Because of inflation, people may think, ‘I’m going to have to get what I need and pay for it later in these installments,’” she said. “But are you still going to be able to afford the things you’re affording now six months from now?”
Q: Why do retailers offer buy now, pay later?
Answer: Retailers accept the backend fees of buy now, pay later services because the products increase cart sizes. When shoppers are given the option to pay off purchases in installments, they're more likely to buy more goods in one go.
When Apple recently announced it will be creating its own buy now, pay later service, Josiah Herndon, 23, joked on Twitter about “paying off 6 carts of (things) I can’t afford with Apple, Klarna, Afterpay, PayPal Pay in 4, Shop Pay in 4, & Affirm.”
Herndon, who works in insurance in Indianapolis, said he started using the services because it was taking a long time for him to be approved for a credit card, since his age meant he didn’t have an extensive credit history. He’s since used them to pay for high-end clothes, shoes, and other luxury goods. Herndon said he lines the payment schedules up with his paychecks so he doesn’t miss installments, and called the option “very convenient."
Q: Who should use buy now, pay later?
Answer: If you have the ability to make all payments on time, buy now, pay later loans are a relatively healthy, interest-free form of consumer credit.
“If (the loans) work as promised, and if people can avoid late fees and don’t have trouble managing their finances, they have a place,” said Saunders, of the National Consumer Law Center.
But if you're looking to build your credit score, and you’re able to make payments on time, a credit card is a better choice. The same goes if you want strong legal protections from fraud, and clear, centralized reporting of loans.
If you're uncertain whether you'll be able to make payments on time, consider whether the fees charged by buy now, pay later companies will add up to higher charges than the penalties and interest a credit card company or other lender would charge.
Q: How will economic instability affect buy now, pay later?
Answer: As the cost of living increases, some shoppers have started breaking up payments on essentials, rather than just big-ticket items like electronics or designer clothes. A poll by Morning Consult released this week found 15% of buy now, pay later customers are using the service for routine purchases, such as groceries and gas, sounding alarm bells among financial advisors.
Hicks points to the rising number of delinquent payments as a sign that buy now, pay later could already be contributing to unmanageable debt for consumers. A July report from the Fitch ratings agency found delinquencies on the apps increased sharply in the 12 months that ended March 31, to as high as 4.1% for Afterpay, while credit card delinquencies held relatively steady at 1.4%.
“The increasing popularity of this is going to be interesting to see over these different economic waves,” Hicks said. “The immediate fallout is what’s happening now.”
AP Personal Finance Reporter Cora Lewis contributed to this report from New York.
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