Americans have increasingly bought into financing options while shopping during the pandemic, yet it has led many into surprising debt.
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When Leondra Garrett wanted to stock up on three new pairs of shoes early last year, the North Carolina resident split a $161 online purchase into four installments through a “buy now, pay later” service, in what seemed like a convenient deal.
Now, she admits she should have read the small print about missed payments.
When the buy now, pay later (BNPL) provider tried to withdraw a payment from Ms. Garrett’s bank account a few months later, she did not have enough funds to cover it. Soon after, the 42-year-old was charged $40 in penalties and her credit score dropped 10 points to 650, a reading generally classified as “fair.”
“It’s important for consumers to always read the fine print and we don’t always do it,” said Ms. Garrett, a community organizer from Charlotte.
So-called buy now, pay later services—offered by providers such as Affirm Holdings Inc, Klarna, Afterpay Ltd and PayPal Holding Inc’s “Pay In 4”—have blossomed across retail websites during the coronavirus pandemic as people have turned more to shopping online.
Yet the ease with which many shoppers can make purchases is worrying some regulators around the world, who fear consumers may be spending more than they can afford.
Nearly 40 percent of U.S. consumers who used BNPL have missed more than one payment, and 72 percent of those saw their credit score decline, according to a study by Credit Karma, which offers customers credit score checking for free.
The study, conducted for Reuters, surveyed 1,038 adult consumers in the United States to gauge interest in buy now, pay later and found 42 percent of respondents had used the service before.
“The percentage of consumers missing payments is remarkable and not as low as you would expect,” said Gannesh Bharadhwaj, general manager for credit cards at Credit Karma.
“When you make something so convenient, people may not be really thinking, ‘Do I have the budget? Can I afford this payment?’ You get more of that impulse-shopping behavior that leads to realizing they may not be able to make the payment.”
A lower credit score signals to lenders that a consumer may be higher risk and makes it harder for the consumer to borrow, whether to secure a mortgage or a new credit card. It can even make it more difficult for a consumer to set up utility accounts or find housing, as landlords will generally conduct credit score checks before renting out apartments.
Management consultants Oliver Wyman estimate BNPL firms facilitated between $20 billion-$25 billion in transactions in the United States last year, although analyst estimates on the size of the BNPL industry vary because it is relatively new and some of the companies are private. Individually, they described explosive growth last year as their services became more prevalent.
Australia-based Afterpay said it saw active U.S. customers more than double to 6.5 million in the fiscal year that ended June 30, 2020, and its sales more than tripled in the July-September quarter from a year earlier.
Over half of Afterpay’s customers in the United States are millennials, aged 25 to 40 years-old, it said.
BNPL models vary, with some companies earning most profits by collecting fees from merchants at the point of sale, and others charging interest and late fees to consumers. They say their services help merchants to boost sales and consumers to buy things they need, and cause less financial damage than credit cards because of restrictions they impose.
Nonetheless, regulators in Britain and Australia are reviewing or tightening rules around the industry. BNPL service providers, classified as fintech companies, should be subject to stricter rules more like banks, some regulators say.
It is unclear how buy now, pay later fits into U.S. regulations because the companies that offer these services do not have bank charters, some do not charge interest and laws vary by state.
San Francisco-based Affirm saw its revenue rise 93 percent, to $509.5 million, in the fiscal year that ended in June. It allows shoppers to split up purchases in terms ranging from six weeks to four years, with interest rates of 0 to 30 percent.
Affirm shows customers how much a loan will cost in dollar terms and does not charge late fees or compound interest. Although missed payments can affect credit scores, Affirm says it has been working with borrowers who fell on hard times during the pandemic.
“We approve borrowers only for what they can comfortably afford to repay,” said Silvija Martincevic, Affirm’s chief commercial officer. “The reason our technology is significant is that we use machine learning to make underwriting decisions.”
At Australia’s Afterpay, customers are barred from using its services after they miss a payment.
The company says 95 percent of its transactions globally are paid back on time and late fees contribute less than 14 percent of the company’s total income.
PayPal’s “Pay in 4” service, launched widely across the United States in November, allows customers to split purchases ranging from $30 to $600 in four interest-free payments. Late fees may apply for missed payments, depending on the user’s state of residency, according to its website.
Pay in 4 in the United States does not report trades or late fees to the credit bureaus, said Greg Lisiewski, PayPal’s global vice president of Global Pay Later.
“We are working with the industry and the consumer credit bureaus to develop the appropriate framework,” he said.
Sweden-based Klarna saw fast growth over the past year, especially purchases in the $100-$200 range, said its U.S. head, David Sykes.
Most of Klarna’s loans are small, of short duration and interest-free, which is safer for customers than credit cards, he said. Customers can delay one payment without a penalty. Late fees vary by state in line with regulation, up to a maximum of $21 and the company is rolling out a 25 percent cap.
“No one is getting buried in debt with Klarna,” Mr. Sykes said. “We aren’t making multi-year loans on a car or a house.”
Smaller loans with shorter durations do have benefits, but they are not risk-free, experts said. Customers may be taking on more debt than they can handle, even if it comes in bite-sized portions.
Tamika Rivera, a 35-year old insurance agent from Springfield, Massachusetts, uses multiple buy now, pay later services, and has missed payments. In one case, she did not have enough money to cover a $43 sweater purchase, which resulted in a $35 overdraft fee from her bank.
“These services are convenient but there are some negative things that can happen,” Ms. Rivera said.
Alan McIntyre, head of Accenture’s global banking practice, says the credit impact of the buy now, pay later trend remains to be seen.
“The optimistic take is that millennials don’t want to get into debt and they want to build a budget better—this is deferred debit and you are not tempted to roll it over,” he said.
“The pessimistic view is that around 40 percent of people using it are doing so because they couldn’t get access to traditional credit—either because they’ve maxed out their credit limit or because of a poor or non-existent credit history—and some of these loans might not season well.”
The financial traps of BNPL programs are just one among many setbacks Americans have had to grapple with as the pandemic brought the largest global recession in history. More than 2 in 5 (42 percent) U.S. citizens said their household financial situation has gotten worse, according to a survey by NerdWallet. The majority of those who said their finances had become worse said it was because their household income decreased. Other reasons included an unexpected large expense, increased household expenses, or a lost job and unemployment benefits ran out. These circumstances have led to surging debt levels during 2020.
According to the Federal Reserve, the amount Americans owe in credit card debt reached an all-time high of $1 trillion in 2020. Adding all other forms of revolving debt, including mortgage, auto and student loans, the average citizen owes more than $90,400.
CNBC reported: “During the coronavirus crisis, more than half, or 51%, of adults with credit card debt—roughly 51 million people—added to their balances, according to a report by CreditCards.com.”
To add to the burgeoning debt levels, roughly three-in-five Americans admitted that they had run out of savings last year, or that their savings will run out by the end of this year, according to the NerdWallet survey.
For many, the downturn was a call to change how they handle their expenses to reduce debt. According to the survey, “more than 3 in 5 Americans said they were spending less on shopping (63%), restaurant food (62%) and transportation (62%)” during the pandemic. “For those who aren’t experiencing a drop in income along with lower spending, they may have extra money in their budget to allocate toward financial goals.”
Several people are striving to find ways to balance their financial situation and reduce spending. That is where the buy now, pay later program can become particularly deceptive—you can make the purchases you want at a lower cost up front, seemingly “reducing” your spending. However, these small payments add up and, if not careful, you can commit to more than you can afford.
The following tips from our booklet Taking Charge of Your Finances will help you manage your spending and get out of debt:
Create a budget and stick to maintaining it. A budget helps one plan, specifying how a family’s or individual’s income should be spent over a designated period. When creating a budget, all income must be calculated, followed by expenditures.
Before making a purchase, you must ask: (1) Is this something that I want? (2) Is this something that I need? (3) Can I do without it? (4) Does the budget allow for this purchase?
If you do not have the money to buy something—do not buy it!
Lower your standard of living and avoid unnecessary spending. If you ask three people, one making $25,000, one making $50,000 and another making $100,000, about the status of their financial situation, all three will likely answer that they are barely making enough to “get by.” This attitude is prevalent—most are never satisfied with what they have.
Stop the cycle of borrowing to pay for expenses.
Remember, a wise family should learn to live with credit—never by credit!
Check the balance of your accounts frequently. If you encounter charges that you were not expecting, call your credit card company or bank and ask about them.
Do not carry multiple credit cards. If you have had problems with overspending, it will take some time to develop self-control. In the meantime, do not allow yourself the temptation to have many credit cards in your purse or wallet—thus allowing yourself some “cushion” to spend what you do not have! Carry one credit card for emergency purposes only.
Pay at least $15-20 more than your minimum monthly payment. Most often, the minimum payment only affects the monthly interest, and does not include much, if any, principal.
Before making a large purchase, think about it for a number of days. You may even want to schedule a savings plan, which will allow you to save portions of the purchase price over a period of time. This would then allow additional time to think about it, helping ensure that you are making a wise purchase. Remember, it is always better to “sleep on” a decision than to jump in impulsively and later regret your action.
Consolidate multiple credit card bills onto one credit card with a low interest rate. Pay off bills with higher interest rates first.
If your interest payments are higher than you can pay, try renegotiating your interest rate with your creditors.
Teach your children to budget and save money. If properly instilled now, these principles will stick with them throughout adulthood. Imagine the benefits of learning, at a young age, rules and laws that have been proven to work!
Taking Charge of Your Finances contains many more practical and helpful points about finances, including from a source most do not associate with the topic.
“Some mistakenly assume that God believes money is evil, and that Christians should be poor,” the booklet states. “They directly associate having riches to the lustful, sinful lifestyles of the wealthy, taking on the belief that ‘humble Christians’ must live in squalor and poverty to demonstrate ‘true’ Christianity.”
“But this thinking is simply not true!”
Read the entirety of the booklet. You cannot afford to dismiss it as a resource toward finding true economic success.