Buy Now, Pay Later: Interest-Free Isn’t Risk-Free

By Nadine Chabrier, senior policy and litigation counsel at the Center for Responsible Lending

With holiday shopping now upon us, using a point-of-sale installment payment option to break up payments may sound like an easy and convenient way to cross names off your list.

Buy now, pay later. Sounds too good to be true, right?

That’s because it is…

Buy now, pay later (BNPL) has exploded in growth, especially since the start of the pandemic when more Americans started spending more time at home and spending more money online. While the pandemic has waned, e-commerce and digital spending has remained strong, as has the use of BNPL.

As reported by Reuters, BNPL has been “one of the fastest growing segments in consumer finance, with transaction volumes hitting $120 billion in 2021 – up from just $33 billion in 2019, according to GlobalData.” The number of Americans using BNPL has increased by 300% every year since 2018.

BNPL is a credit product often marketed as a cheaper, easier alternative to credit cards. It allows consumers to split the cost of their items into payments, typically four, that last anywhere from a few weeks to a few months.

Morning Consult research shows that:

• Gen Z, Black and Hispanic consumers are more likely to use BNPL than others.
• One in three BNPL users overdrafted a bank or credit union account in January 2022.
• Consumers who used BNPL were twice as likely as the general population to have overdrafted a bank or credit union account during the survey time period.

Keep in mind that every time a person overdrafts their account, they’re typically charged a fee around $35.

Taglines like “Shop and Slay with Afterpay” are emblematic of BNPL advertising geared toward the youngest generations. Alongside the words “interest free” and extra offers, like free shipping, BNPL can look like an affordable and safe credit option.

Along with Afterpay, other big BNPL lenders are Affirm, Klarna, PayPal, Zip and Sezzle, but more are continually introduced. In fact, Apple recently announced its entrance into the market with its own option, Apple Pay Later, that is integrated into Apple Wallet – which itself comes with every iPhone.

While BNPL providers tout zero interest fees, the devil is in the details. While there may not be interest or fees initially, if borrowers miss a payment, many providers will charge deferred interest retroactively for the entire balance and/or apply late fees. Further, the zero percent interest may not be for the entire length of the loan, which could leave consumers with expensive and unexpected charges later. And if consumers pay with a credit card, interest may begin accruing on the card if the payment isn’t paid in full as part of a user’s monthly statement.

Marketed as interest-free, consumers may end up being charged more than they think they will. If a consumer has multiple buy now, pay later purchases, they can easily lose track of their payments, which could result in numerous fees for missed payments, account reactivation, rescheduling and other hidden fees they weren’t aware of at the outset.

BNPL lenders often don’t assess a borrower’s ability to repay the loans, and accounts can be debited even if the borrower has insufficient funds, which could trigger an overdraft fee. Further, surprise fees and inadequate disclosures make it difficult to compare costs and make the true cost of a BNPL loan difficult to ascertain.

The potential for unaffordable debt is high; even without interest charges, a loan can be impossible for a consumer to repay if the principal is too high. Further, BNPL lenders sell themselves to merchants by arguing that their service demonstrably results in higher sales volume. People can quickly get in over their heads.

The Consumer Financial Protection Bureau’s (CFPB) “Buy Now, Pay Later: Market trends and consumer impacts” report notes that BNPL may encourage overextension through loan stacking and sustained usage, both of which impact consumers’ ability to meet other obligations.

“If Buy Now, Pay Later lenders incorporate the protections and protocols that we observe in other financial products, this would go a long way to ensure that there is healthy competition where consumers have a baseline level of protections,” CFPB Director Rohit Chopra said in prepared remarks on the release of the agency’s buy now, pay later report.

We commend the CFPB for its market monitoring inquiry into BNPL and its effects on consumers and on the credit reporting system and for the report released in September. When it launched the inquiry, the CFPB recommended the industry adopt standards for reporting data to consumer reporting companies and that these companies incorporate BNPL data into core credit files as soon as possible. Additionally, it recommended credit scoring companies and lenders to build and calibrate models that account for BNPL loans’ unique lending characteristics.

Further actions being considered by the CFPB include creating guidance or rules that establish baseline protections similar to those for credit cards, identifying surveillance practices that may need to be curtailed and ensuring BNPL companies are subjected to appropriate supervisory exams.

CRL recommends the CFPB use its authority to continue to collect, analyze and publish data from BNPL providers to analyze the risks; supervise large BNPLs to ensure they are not engaging in unfair, deceptive or abusive acts or practices and enforce the Electronic Fund Transfer Act’s ban on compulsory repayment of credit by preauthorized electronic fund transfer.

Finally, as outlined in a comment letter to CFPB Director Rohit Chopra, anti-discrimination laws should be applied to new lending platforms like BNPL. Early data show a disproportionately higher use of BNPL by young adults as well as by Black and Latino Americans, which raise questions about how lenders reach these communities and their experience in this financial marketplace.

Caution by the consumer is warranted for every financial transaction; it should be even higher in a largely unregulated space like BNPL loans. Moreover, the complexity of these transactions and the potential for fraud make consumer preparedness important but nowhere near sufficient. As we saw most dramatically in the run-up to the 2008 Financial Crisis, it is the role of government to ensure a market for safe products and services for consumers to choose from.?