New Studies Unveil the Risks of 'Buy Now, Pay Later'

As Buy Now, Pay Later (BNPL) plans become increasingly popular, concerns are rising about how to regulate them.

On one hand, they might provide a way for people to buy things they need while improving their credit scores. On the other hand, they might become debt traps and a way for companies to make money selling their personal data.

The benefits and risks of BNPL were reviewed in a string of reports released this week and one released in April by researchers at Harvard University’s John F. Kennedy School of Government.

In December, the CFPB opened an inquiry into BNPL, requesting information from Affirm, Afterpay, Klarna, PayPal and Zip. “The process will likely reveal consumers’ struggles to pay their BNPL balances,” according to a report released Tuesday by Strategic Resource Management (SRM), an independent advisory firm based in Memphis, Tenn.

The Harvard researchers found delinquent credit repayment rates are substantially higher for BNPL than for credit cards: Three times higher at 30 days or more past due and two times higher at 90 days or more past due.

The typical pay-in-four model for BNPL is simple for consumers to understand. A consumer pays $25 at checkout for a $100 item and then makes three monthly $25 payments.

While a typical card balance is $1,100, a single BNPL balance is a manageable $125.

“However, the products are so user-friendly that they induce increased spending and drive some of the same negative consumer consequences of high-interest products,” the Harvard researchers said. “If consumers make multiple BNPL purchases across multiple BNPL products, it can be incredibly difficult for them to track aggregated upcoming payments.”

The Harvard Kennedy School working paper released April 15 is “Grow Now, Regulate Later? Regulation urgently needed to support transparency and sustainable growth for Buy-Now, Pay-Later.” The paper was written by Marshall Lux and Bryan Epps, two researchers at the school.

The Harvard researchers concluded that “legitimate oversight from the public sector is necessary to protect consumers in the long-term in a sector with so many remaining uncertainties.”

“Given the rapid adoption of BNPL products in the U.S. and the considerable potential for harm to consumers, near-term consumer protection is essential,” they said.

The Harvard researchers said “the consumer credit market has been ripe for disruption.” because of the increasing number of unbanked Americans and rise in credit card regulatory restrictions by financial regulators.”

“Consumer preference for BNPL is unsurprising in an environment where demand for and constraints to new consumer credit are high, especially for lower income Americans,” the Harvard researchers said.

BNPL isn’t new. The Harvard researchers point back to the “Sign and Fly” program launched in the 1960s, in which American Express provided point-of-sale financing for American Airlines flights.

BNPL products focused on consumer goods have seen the most growth in recent years. These include PayPal Pay-in-4, Affirm, Afterpay and Klarna.

BNPL obligations and data are beginning to surface on credit reports. This could prove valuable to improve credit scores for users who have little credit history or poor credit history. Or it could lower their scores.

The Harvard researchers pointed out another value to traditional commercial banks and other financial institutions big enough to buy a BNPL company by providing “a far more affordable means of customer acquisition.”

An annual survey of household economic well-being released by the Federal Reserve on Monday included questions for the first time about BNPL.

The Fed survey found 10% of people used a BNPL service in the previous 12 months. About 7% were making payments under a BNPL plan at the time of the survey — late October and early November 2021 — with about half paying on just one purchase.

The survey found convenience was the most cited reason for using BNPL: 78% of users.

The survey found the use of BNPL services had only a weak relationship to income and education. And the use was the same among those who had a credit card and those who didn’t.

However, the Fed found late payments for BNPL were significantly higher for those with lower incomes, lower education and among those without a credit card.

For example, 10% of those with a credit card and 10% of those without a credit card had used BNPL within the last 12 months. But among those with a credit card, 14% reported a late BNPL payment, while 23% of those without a credit card reported a late payment.

TransUnion, the Chicago credit reporting agency, found a stronger link to age and credit risk. Its report released Wednesday relied on more than nine million consumers with a point-of-sale (PoS) financing inquiry from the fourth quarter of 2019 to the fourth quarter of 2021.

Gen Zers and millennials (ages 18-40) made up 35% of those in TransUnion’s database of people with active credit, but they accounted for 61% of consumers who applied for BNPL financing during the study period.

TransUnion also found PoS financing applicants were more likely to belong to higher risk tiers. About 43% of all PoS financing applicants were found to belong to the subprime risk tier, compared with 15% of the credit population.

Salman Chand, vice president of consumer lending at TransUnion, said consumers are drawn to BNPL and PoS lending by their simplicity and convenience.

“Consumers who are most likely to utilize Point-of-Sale financing tend to be younger and below prime,” Chand said. “But as this market matures, we will likely see more consumers across the board becoming aware and starting to use these products.”

The SRM report recommended that banks and credit unions “give serious strategic consideration to BNPL,” but it did not describe what that might look like.

SRM said many banks and credit unions are leery of BNPL in part because these tightly regulated financial institutions “have encountered significant reputational risk and material fines for falling short of rules that often lack clarity.”

Meanwhile, SRM said, “competing startups tend to use an ‘ask forgiveness rather than permission’ approach, testing how far they can push the boundaries confining financial institutions.”

Tighter regulation of BNPL plays to the strength of banks and credit unions. Many laws that the CFPB could enforce with BNPL – including the Truth in Lending Act and the Fair Credit Billing Act – are already followed by traditional financial institutions.

“Rather than fear regulation, banks and credit unions should instead be thoughtful about it,” SRM said. “Any actions taken will prove to be a competitive advantage for financial institutions, which have the infrastructure in place to implement any mandated guardrails rapidly and are unlikely to engage in the envelope-pushing aspects of BNPL that require a course correction.”

The Harvard researchers found BNPL programs for consumers have struggled to make a profit, raising concerns at the CFPB and elsewhere that they might depend on selling the valuable data they collect on borrowers.

“The CFPB is not alone in its concerns about BNPL: Financial institutions and investors have expressed apprehension about the value proposition and overall impact of BNPL products,” the researchers said. “Based on our many interviews, venture capitalists have also increasingly shied away from consumer facing BNPL in favor of innovation in BNPL infrastructure and B2B BNPL products.”