#: ‘The proverbial Wild West’: Read this before using ‘buy now, pay later’ this holiday shopping season

“This is debt,” Ted Rossman, senior industry analyst at Bankrate.com, told MarketWatch. “I don’t think people often think of it that way. I think that it’s kind of deceiving, and that can be a bit of a slippery slope.”

Among the big players in the buy now, pay later (BNPL) industry: Afterpay
APT,
-1.78%,
an Australian financial technology company that recently agreed to be acquired by Square
SQ,
-5.64%
; San Francisco-based Affirm
AFRM,
-5.72%
; and Klarna, a Stockholm-based fintech which has received funding from Softbank
9984,
-0.71%.

They have made it easier for consumers to shop and, as such, blow their budgets. These services loan consumers money that allows them to purchase an item immediately, and pay that money back — usually interest-free — in a predetermined number of installments spread out over several weeks.

How do these services make money?

Suddenly, a $200 jacket becomes four payments of $50 every two weeks, automatically debited from your bank account. So how do these services make money?

Affirm offers payments at an interest rate between 0%–30% APR based on a customer’s credit score, but does not charge late fees. Its biweekly payment option is interest free, and the company says it makes most of its money from merchants rather than customers.

Afterpay loans are interest-free with a 25% upfront payment and another 25% payment every two weeks until the loan is fully paid. Late fees apply: An initial $10 late fee, and another $7 if the payment remains unpaid seven days after the due date. Late fees are capped at 25% of the original purchase amount.

Klarna also offers interest-free payments on its “Pay in 4” plan. “If we are unable to collect a biweekly payment on the scheduled day, we will try again,” the company says. “If the payment is unsuccessful when we retry, a late fee of up to $7 and the missed payment will be added to the next scheduled payment.”

Klarna also offers a monthly financing option that allows consumers to spread payments over time for up to 36 months, with 0-25% APR. “If the monthly payment due is not made by the due date each month, you can be charged up to $35.00 per missed month,” the company says. “The amount of your late fee will not exceed your minimum payment due.”

U.S. retailers Seattle-based Amazon
AMZN,
-1.38%
and Bentonville, Ark.-based Walmart WMT work with Affirm, making it easy for shoppers to use these services at checkout. With Amazon, consumers can use BNPL on eligible purchases of $50 or more. Walmart has a range of BNPL items from TVs to furniture.

It’s no surprise that the BNPL model gained popularity during the pandemic as cash-strapped Americans turned to online shopping for nearly all their needs. The services are especially popular among younger consumers — nearly 75% of BNPL users are either Gen Z or millennials, according to Insider Intelligence. 

Since the partnership with Affirm began with Walmart in 2019, the program has provided flexible payments and “served millions of customers and is one of Walmart’s fastest growing financial services products,” Walmart said in a statement to MarketWatch. Amazon did not respond to a request for comment.

Critics say consumers should proceed with caution. Buy now, pay later “is kind of the proverbial Wild West: Sometimes it works for you, but sometimes you kind of slip through the cracks a little bit,” Rossman said. In other words, despite their best intentions, people incur late fees and/or pay high rates of interest.

So before you use buy now, pay later for your holiday shopping, here’s what you should know about the potential pitfalls of the service.

‘People spend more when they use buy now, pay later’

“The biggest pitfall is that consumers tend to overspend,” Joe Buhrmann, senior financial planning consultant at eMoney Advisor, said. In fact, BNPL users plan to spend on one gift what the average shopper plans to spend for the entirety of their holiday shopping this season, according to a Morning Consult report.

“I think there is an impulse element to this, and that these companies do make a lot of money by partnering with retailers. There’s a lot of data that people spend more when they use buy now, pay later, [and] they come back again and again,” Rossman added.

“We’re generally talking about a population that maybe doesn’t have great credit or maybe doesn’t have much experience with credit. I think especially when we’re talking young adults, there’s definitely a potential to get in over your head without even realizing it,” he added.

BNPL is not as tightly regulated as other financial services

Considering BNPL is the “proverbial Wild West,” as Rossman said, the industry doesn’t have the same kind of regulations as other financial products. Whereas credit-card issuers are required to consider a consumer’s ability to repay loans, BNPL lenders are not.

Klarna conducts “robust eligibility assessments on each and every transaction a consumer attempts to make, so we only lend to those who can afford to repay,” a spokesperson told MarketWatch via email. Klarna said it supports “reasonable regulation” for BNPL and that it’s comfortable “operating in a regulated environment.”

“We do not, however, believe no-interest products should be regulated in the same way as high-interest products, which could ultimately impact our ability to provide responsible credit alternatives to millions of Americans,” a Klarna spokesperson said.

Affirm said it has models that continuously learn and that have been “built on billions of data points, over the course of our near-decade of operations and considers data beyond traditional credit scores, including transaction history and credit usage, to assess a consumer’s ability to repay.”

Affirm also told MarketWatch that it is “subject to extensive regulation, both directly and indirectly, by way of our partnership with our originating bank partners, under federal and the laws of the states in which we operate. This includes licensing regulations in states that require licensing of our pay in four product with 0% APR and no late fees. We are committed to providing consumers with greater choice, transparency and flexibility at checkout and we support efforts that help advance our mission to improve lives.” 

“Afterpay is subject to key consumer protection laws and regulations, including anti-money laundering, fair lending, credit reporting, debt collection, privacy, fair treatment of customers, and electronic fund transfers,” a spokesperson told MarketWatch.

BNPL can make returns complicated, especially when it comes to consumer disputes, Rossman added. “Anytime a middleman gets involved, it can be kind of confusing,” he said. “Sometimes, even after you’ve sent an item back to the merchant, the buy now, pay later company is still asking for its cut.”

Klarna noted, for one, that customers who have made a return and are waiting for the retailer to register it can pause their payments through their Klarna account.

What happens if you fall behind on installments?

A whopping 34% of BNPL users have fallen behind on their payments, a Credit Karma survey found, and 72% of those who did fall behind believed the missing payment hurt their credit score.

Younger users are more likely to miss payments, the Credit Karma survey found. More than half of Gen Z and millennial users report missing payments, compared with 22% of Gen X and 10% of baby boomers.

“With numbers like this, it’s important that BNPL users don’t get in above their heads and get caught in a vicious payday-loan type of cycle,” Buhrmann said.

Some players within the industry pushed back on those delinquency figures. Affirm’s 30-day delinquency rate was approximately 1% for 2021, the company says.

Other than a few instances, the BNPL services largely take place outside of the traditional credit-scoring system, Rossman said. Some companies do what’s called a “soft” credit check when you sign up for a BNPL plan, so there’s no impact to your credit score there.

But the BNPL companies say they have systems in place to help prevent their customers from falling behind in payments.

Afterpay uses a proprietary risk system model for each transaction, and doesn’t conduct soft credit checks, Zahir Khoja, general manager of Afterpay’s North America division, told MarketWatch. Afterpay also does not report to the credit bureaus, Khoja said.

However, for some of these services, if you pay really late — typically 90 or more days late — “there’s a pretty good chance that you’ll be reported to the credit bureaus and that could hurt you,” Rossman said.

Klarna has multiple checks in place to help customers make sure they don’t miss payments, including emails and in-app notifications, a Klarna spokesperson said.

That customer is then unable to use Klarna until they make their late payments, and also has limited access to the service going forward so “they are unable to accrue additional debt — unlike the traditional credit model,” Klarna said.

But if a Klarna customer continues to not make the repayment, it’s turned over to debt collection, which occurs approximately 82-90 days after purchase, a Klarna spokesperson said.

On Afterpay, if the customer continues to go late, their ability to use the platform is suspended until payment is made. “In very certain circumstances, we may work with third-party agencies to collect on those funds, but we only work with agencies that have that light, friendly approach,” Khoja said of Afterpay.

For its part, Affirm does not charge late fees. After 120 days of delinquency, the customer’s account is placed with a third-party debt collector. The company says Affirm oversees its third-party collectors to ensure they meet its standards of consumer care and treat customers with respect and care.

Think of the total price, not the installments, and stay organized

“A lot of people end up overspending, because they do multiple plans, and then they get confused and disorganized and they pay late, and then there’s fees associated with that,” Rossman said.

If you are going to use BNPL, “be sure to write down the purchase price, the amount remaining, the payment amounts and the schedule of payments. Put the list in a prominent place so these seemingly small amounts won’t slip through the cracks and weaken your financial health,” Buhrmann said.

Think of the total price when you’re deciding whether to purchase the product, Rossman said. “There’s this kind of mental accounting that I think sometimes hides the true amount that you’re spending.” So think of it as a $200 jacket, not four payments of $50.

You can set up automatic payments, but make sure you actually have that money in your account to avoid overdraft fees.

“Ideally, what you would do is use a credit card, get the rewards, get the better buyer protections and pay in full before interest hits, but of course some people don’t like that or they need more time or they don’t have good credit,” Rossman said. “So there are times buy now, pay later could work, but I would tread carefully personally.”