A new way of paying buy now pay later for purchases is becoming a trend, but it could also become a trap for the US economy, and no one knows how big it is.
What are buy-now pay-later plans, and why are they popular?
Buy now pay-later plans became more popular in 2023 as a way to avoid high-interest credit cards.
These loans are risky, and many of them are due after the holiday season.
These debts could also weigh down the economy, but no one knows how widespread they are.
Consumer spending helped the economy stay afloat in the second half of 2023, and one of the main drivers was the rise of installment plans, also known as “buy now pay later” (or BNPL). However, these loans are not well-regulated, and they are called “phantom debt” because no one knows how much they affect the American consumer.
In a report from Wells Fargo published in December, the company’s economists estimated that buy now, pay later loans reached $24.4 billion in 2021, or about 2.5% of the US credit card market that year. That was a 1,000% increase from 2019, and that number could be even higher now. The Federal Reserve Bank of Philadelphia said in 2022 that one of the reasons we don’t know much is that buy now pay later companies often don’t report to credit agencies.
BNPL loans are not currently reported to any of the major credit reporting agencies, and the firms themselves are understandably reluctant to share proprietary data in a competitive environment,” the Fed said.
If too many consumers fail to pay their debts, these installment plans could also hurt the US economy.
How did buy now pay later, use spike during the holidays, and what are the consequences?
The use of buy-now, pay-later plans soared during the 2023 holiday season. According to Adobe, which tracks online sales, buy now pay later plans were used by 47% on Black Friday and 43% on Cyber Monday.
Instead of using credit cards, which have record-high interest rates, you can use an installment plan that lets you pay off the debt in a certain amount of time without interest, usually in eight weeks or four months.
If consumers spent more than they could afford during the holidays and didn’t make payments on their buy now pay later plans, they could face late fees and interest rates of around 30%.
Installment loans can offer credit to some Americans who might not qualify otherwise. However, an August survey of 2,572 consumers by financial news and data platform PYMNTS found that nearly 64% of high-income earners—defined by PYMNTS as those making at least $100,000 a year—had used installment plans in the previous 12 months. That was higher than the overall rate of 60%.
Of course, most consumers expect to pay their loans on time. The Fed’s “2022 Survey of Household Economics and Decisionmaking” found that 83% of respondents paid off their buy now pay later plans on time.
But some people who pay their loans are just postponing the problem. A Social Science Research Network study found that some consumers pay off their buy now pay later plans with credit cards, which swap a 0% interest rate for rates often above 20%.
While installment loans might be better for big-ticket items, these are not the most common purchases. According to PYMNTS’ survey, 39.6% of respondents used the buy now pay later plans for clothing and accessories, and 33.7% used them for groceries.
Why are buy now pay later plans a ‘phantom debt’ and how could they surprise the US economy?
Wells Fargo economists Tim Quinlan and Shannon Seery Grein wrote that buy now pay later plans could lead to more financial stress for consumers who are already struggling with debt and income loss due to the pandemic. They also warned that these loans could pose a systemic risk to the economy if they are not properly regulated and monitored.
“Without a clear picture of the size and scope of the BNPL market, it is difficult to assess the potential impact on consumer spending and credit quality,” they wrote. “Moreover, the lack of transparency and oversight could create vulnerabilities in the financial system that could amplify shocks in times of stress.”
Buy now pay later. Plans are not regulated in the same way as credit cards or other forms of consumer credit. They are not subject to the Truth in Lending Act, which requires lenders to disclose the terms and costs of credit to consumers. They are also not subject to the CARD Act, which limits the fees and interest rates that credit card issuers can charge.
This means that buy now pay later providers have more flexibility and discretion in setting their terms and conditions, which may not be clear or consistent across different platforms and merchants. Consumers may not be aware of the potential fees, interest rates, and penalties that they could face if they fail to pay on time or in full.
Moreover, buy now pay later providers are not required to report their transactions and performance to the credit bureaus, which makes it difficult to measure the size and scope of the market and its impact on consumer credit and spending. This also means that consumers who use buy now pay later plans may not benefit from building their credit history and score, which could limit their access to other forms of credit in the future.
The lack of regulation and transparency also raises questions about the financial stability and resilience of the buy now pay later industry and its implications for the broader economy. As the market grows and becomes more competitive, buy now pay later providers may face more pressure to lower their standards and offer more risky loans to attract and retain customers. They may also face more challenges in managing their liquidity and credit risk, especially in times of economic downturn or market volatility.
If buy now, pay later providers experience financial distress or default, they could transmit shocks to their partners, investors, and customers, which could have ripple effects on the financial system and the economy. This could be especially problematic if buy-now pay-later debts are securitized and sold to investors, as some providers have done or plan to do.
Buy now pay later plans are a convenient and attractive way to finance purchases, but they are not without risks and costs. Consumers should be careful and responsible when using them, and regulators should be vigilant and proactive in overseeing them. Otherwise, the phantom debt of buy now pay later could haunt the US economy as a hidden debt.
Conclusion, buy now pay later
plans are a new and popular way of paying for purchases, but they also pose risks and challenges for consumers and the economy. These plans are not well-regulated and transparent, and they could create a hidden debt that could harm the financial system and the economic recovery. Consumers should be aware of the potential costs and consequences of using these plans, and regulators should monitor and oversee them to prevent any negative impacts. Buy now pay later plans are not a free lunch, and they could come back to haunt the US economy as a phantom debt.