Anyone who has shopped online in recent years has come across one of the many short-term financing options known as buy now, pay later at checkout. And while they may seem tempting, the hidden risks discovered by researchers suggest that buy now, Ache later might be a more suitable label.
According to a study recently highlighted by the Stanford Graduate School of Business, using BNPL programs can lead to negative financial consequences for the average user, with effects ranging from overdraft fees to interest incurred on credit card balances.
The study team analyzed the banking and credit card histories of 10.6 million Americans between 2015 and 2021 and examined changes in people’s financial well-being after making a purchase with BNPL. It also compared data from more than 570,000 pairs of BNPL borrowers and similar non-borrowers.
What is Buy Now, Pay Later?
Buy now, pay later is pretty much what it sounds like. When a customer goes to check out an order online, they are typically presented with a few payment options. By selecting BNPL, fintech companies with catchy names like Zip and Sezzle pay the merchant upfront rather than the acquirer.
The user typically pays a 25% down payment, receives the order, and repays an interest-free loan in four installments according to a specific timeline (although the terms vary depending on the BNPL provider).
BNPL loans typically cover only smaller purchases, with the average BNPL loan being around $130, according to Experian. Most companies will lend amounts between $50 and $1,000 for products such as clothing, beauty products, groceries, and even gas.
Since it took off, BNPL has become popular among consumers, particularly younger shoppers and those with little or poor credit. A 2022 report from the Consumer Financial Protection Bureau found that among the five BNPL providers analyzed, loan disbursements increased nearly tenfold from 2019 to 2021, totaling more than $24 billion. Today, some retailers, like Sephora and IKEA, even offer BNPL in stores.
Unlike traditional lenders, BNPL companies only perform soft surveys on borrowers to determine their eligibility, making it easier for them to qualify, and the companies do not have to report their data to credit bureaus. But this form of loan also has some disadvantages.
How BNPL affects its users
The team of researchers, led by Stanford Graduate School of Business professor Ed DeHaan, found that while BNPL is a hit with consumers, it can also respond.
“The average user’s financial experience isn’t great,” DeHann said in a recent blog post about the study. “And we have a lot of evidence from history that, left to their own devices, companies that issue credit tend to do so at the expense of consumers when they can.”
In their analysis, the researchers found that 13% of Americans tapped into BNPL between 2015 and 2021. And by 2021, the average borrower was paying $500 per quarter through a dozen BNPL installment payments.
The researchers then assessed the financial health of BNPL users by comparing their data to that of non-BNPL users with similar characteristics, using occurrences of overdraft charges, credit card interest payments, and late fees as measures. BNPL users incurred 4% more overdraft fees, 2.3% more late fees on credit cards, and interest on their credit cards was 1.1% higher than their counterparts not BNPL.
The team also found that a retailer’s offering of BNPL was a powerful indicator of whether a shopper would use the payment option. These users showed an 8.9% increase in overdraft fees, a 2.5% increase in credit card interest, and an 8.4% increase in late fees over the six years analyzed.
All told, this equates to $176 per year in additional costs for the average BNPL user. Particularly vulnerable people, such as those who were ineligible for other forms of credit, paid on average up to $252 a year in additional fees.
Protect consumers from BNPL abuse
A separate report from October 2023 indicates that people may not know exactly what they will get into by taking advantage of BNPL programs.
The analysis, conducted by the Consumer Federation of American and the Center for Responsible Lending, found that respondents had a low level of understanding of how BNPL works. Those with lower incomes were more likely to report using the payment alternative for purchases they couldn’t afford without it.
Although regulators like the CFPB have raised concerns about BNPL’s potential harm to U.S. consumers, the industry still has little oversight. Some states enforce rules: California requires BNPL providers to obtain state lending licenses and follow state lending laws, but there is no federal regulation.
Otherwise, the BNPL industry essentially operates on something of an honor system, with some firms claiming to follow a code of conduct co-created by BNPL providers, the Monetary Authority of Singapore and the Singapore FinTech Association.
Researchers say BNPL is not inherently a bad payment choice, and given its rapid adoption and widespread use, it’s probably here to stay. DeHann said in the blog post that, as with any financial product, oversight is critical to protect consumers and ensure companies are accountable for their lending practices.
He went on to explain that making credit reporting mandatory for BNPL consumers would not only increase transparency but also avoid “debt stacking,” which occurs when consumers open multiple credit accounts at the same time and ultimately fail to manage their debt . The reporting would also reward BNPL users who pay their installments on time.
Since BNPL is a popular option among consumers with limited credit, showing a positive BNPL payment history could help these users build their scores and qualify for other loans in the future.
Beyond that, DeHaan said, fraud protection, standard disclosure and a regulated dispute resolution process are also needed to hold BNPL providers to the same standards as banks and other financial institutions – hopefully keeping consumers safe in the process.
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