Terms and Conditions Need Not Apply

This article appears in the April 2022 issue of The American Prospect magazine. Subscribe here.

The way financial firms sold consumer debt products used to be downright cute. In a 1978 commercial for a company called Access, for instance, an anthropomorphized Schoolhouse Rock!-esque character called Money appears with the business itself as a huge walking credit card. Money complains that he can’t cope with everything he needs to buy. “Don’t worry, leave it to me. I’ll take care of the bills,” says Access, the “flexible friend.” “Aw thanks, Access. You’re a real friend,” Money replies.

Access, alas, no longer exists. Mastercard acquired and then retired the credit card brand in 1997. Since then, traditional credit card debt no longer seems distinctly cute, thanks to wider knowledge of its punishing interest rates and skepticism induced by the 2008 financial crisis.

Fear not! There is a new savvy spending scheme for the financially conscious millennial or Gen Zer: Buy now, pay later (BNPL). Companies like Affirm, Afterpay, and Klarna market themselves as innovative new companies, creating financial freedom for all through flexible payment options. But it’s not a new concept, and at bottom, they’re even worse than credit cards.

INSTEAD OF PAYING for a purchase all at once or in monthly installments (plus interest), BNPLs typically offer four interest-free installments due every two weeks (though not always, as we’ll see below). While consumers take weeks or months to pay off the purchase, the BNPL lender fronts the bill to the retailer.

BNPL’s appeal is deceptively simple; Gen Z and millennials hate debt. A Klarna investor sheet cited an American Psychological Association survey which found that more millennials feared credit card debt than feared death and war. With BNPL, consumers avoid the psychological toll of interest with a product that’s just as easy to use as a credit card.

BNPL’s integration with online merchants is impressive too. Currently, there are millions of merchants worldwide accepting some form of BNPL payment, and with PayPal recently offering the service to any of its 32 million merchants with the click of a button, likely millions more very soon. Whether you’re shopping for last-minute gifts for the holidays, big-ticket electronics, or you came across an ad as you were tapping through Instagram stories, the setup is seamless. BNPL transactions have also begun to show up on credit reports, allowing customers to build credit.

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Last year, 1 in 5 Americans used a BNPL lending scheme, and 1 in 3 who haven’t used BNPL expressed interest in using it in the future. By the end of 2022, almost half of Gen Z in the United States will have used a BNPL service once, and by 2025 BNPL transactions are predicted to amount to $760 billion worldwide, a 92 percent increase from 2019. That would mean 12 percent of all physical goods purchased online through a BNPL service.

BNPL loans have so far sidestepped Regulation Z, which implements the Truth in Lending Act (TILA) to ensure credit term transparency for consumers—mandating a universal language and format so consumers can understand the terms of the agreement they are entering. It also covers deceptive and inaccurate credit billing and credit card practices, and allows consumers to dispute fraudulent charges.

Although the recent updates to Regulation Z implemented additional consumer protections, and longer-term data collection for compliance purposes, BNPL loans are typically structured as installment loans, and Regulation Z does not apply to those types of credit products.

That concerns some policymakers. In a statement to the Prospect, Sen. Sherrod Brown (D-OH) said, “We’ve seen how some buy now, pay later companies have used hidden fees and marketing to mislead consumers into taking on more debt than they can handle.”

There are a lot of hidden downsides, in fact. Klarna charges up to a 24.99 percent annual percentage rate (APR) for purchases on longer payment plans; Affirm charges up to a 30 percent APR for similar services. Afterpay doesn’t charge a traditional interest payment, but does slap on one late fee per late installment; however, the total amount of late fees charged won’t exceed 25 percent of the initial order value.

A financial adviser and host of the podcast She’s On the Money, Victoria Devine recalled in a 2019 episode, “I have people in the She’s On the Money community who have had their mortgages declined because they’ve forgotten to disclose that they have Afterpay debt because they didn’t see it as debt.”

By the end of 2022, almost half of Gen Z in the United States will have used a BNPL service once.

On the business side, merchant fees are higher for BNPL lenders than credit card companies; BNPL lenders charge 1.5 to 7 percent, compared to credit card companies charging 1.3 to 3.5 percent, plus the payment processor’s cut. Despite the higher fees, retailers eat the costs because customers who use a BNPL service spend more than those who do not. Klarna told investors that when using BNPL, the average order value—the average amount spent by customers with a retailer—increased by 68 percent, alongside a 20 percent increase in shopping frequency. What’s more, those fees are passed on to customers through higher prices. According to a co-authored report by PYMNTS and Afterpay, 33 percent of businesses offering BNPL saw increased revenues from 2019 to 2020.

It’s common for people to take on more BNPL debt than they can afford, and that often means a black mark on one’s credit report. The smaller BNPL lender Laybuy reported almost half of its revenue in a six-month period came from late fees, while bigger players like Afterpay—which was recently acquired by founder and former Twitter CEO Jack Dorsey’s fintech company Block—reported that in 2020, $51.8 million of its $399 million in revenue came from the same source. The following year, CEO Magazine reported Afterpay’s revenue from late fees increasing to $99 million. Andrei Stadnik, a senior equity research analyst for Morgan Stanley, has developed models that predict Afterpay’s revenue from late fees will rise to $340 million by June 2023. According to the Australian Financial Review, if the periodic payment calculations used for credit cards were applied to Afterpay’s late fees, it’s an equivalent interest rate of 55 to 68 percent per year.

A report from the U.S. Public Interest Research Group Education Fund found that BNPL borrowers are often harmed by “hidden fees, interest and debt collection problems … consumers also face problems with customer service.”

Justin Baldwin, a 24-year-old living in East Lansing, Michigan, told the Prospect, “J​​ust using [Afterpay’s] service lowered my credit score 30 points.” He could afford the purchase outright but figured on-time payments would boost his credit score. “Ever since I saw [my credit score drop], I decided not to use those online layaway things.”

Functionally, BNPLs are a Wall Street devil’s brew of credit cards, layaway, and a sneaky end run around financial regulation, all in one. The industry’s potential growth is still in its infancy, but long-standing financial titans like Barclays have warned about the proliferation of BNPL services. Last year, the bank conducted a study among 2,000 BNPL users in the U.K., and the results are troubling. The average Gen Z BNPL user spent an average of £175.50 in monthly repayments (US$231), accounting for 20 percent of their monthly discretionary income. Perhaps even more telling, Barclays last year also announced a partnership with Amazon for installment options over £100, which would include interest over the payment period. If BNPLs really take off, financial incumbents will likely simply jump on the bandwagon.

“BNPL’s value should undoubtedly come as a warning sign to incumbent financial institutions, whose sole method of offering finance for eCommerce is the credit card or cumbersome online financing offers,” said the fintech research firm Kaleido Intelligence in a 2020 digital financing markets outlook report.

LAST YEAR, IN AN ATTEMPT to stop BNPL services from circumventing regulation, Sens. Jack Reed (D-RI), Sherrod Brown (D-OH), Chris Van Hollen (D-MD), Elizabeth Warren (D-MA), Tina Smith (D-MN), and Jon Ossoff (D-GA) sent a letter urging the Consumer Financial Protection Bureau to take action governing the rise of BNPL products.

The letter stated, “Many BNPL providers structure these products in an effort to avoid certain consumer protection obligations under the Truth in Lending Act or the Military Lending Act, which generally apply to loans that are repayable in more than four installments or are subject to a finance charge.”

On December 16, 2021, the CFPB announced an inquiry into the leading BNPL companies. CFPB Director Rohit Chopra said, “Buy now, pay later is the new version of the old layaway plan, but with modern, faster twists where the consumer gets the product immediately but gets the debt immediately too. We have ordered Affirm, Afterpay, Klarna, PayPal, and Zip to submit information so that we can report to the public about industry practices and risks.” The report from each of the companies was due March 1, 2022, though none have been released thus far.

The CFPB had three main concerns: First, the ease with which consumers accumulate debt, thereby overextending themselves with several loans on multiple schedules. Second, regulatory arbitrage, referring to the consumer protection laws the companies may be evading, such as not providing dispute resolution protections, which credit cards provide, and identifying the rules the lenders follow in regard to late fees and policies. And lastly, the agency requested information on all five companies’ data-harvesting techniques to figure out practices around data collection, behavioral targeting, data monetization, and the risks consumers face when using BNPL services.

“Depending on the nature and scope of the entity and its involvement in BNPL lending,” a CFPB spokesperson told the Prospect, “some or all of [the agency’s] authorities may be available to constrain illegal activity and to facilitate compliance with federal consumer financial laws.”

Sen. Warren applauded the action. “CFPB is right to take a close look at these products to ensure that consumers are protected from predatory schemes,” she told the Prospect.

The U.K. is far ahead of U.S. regulation. Earlier this year, the country’s Financial Conduct Authority (FCA) ordered BNPL companies to redraft their lending terms.

Afterpay claims it’s “helping people spend responsibly,” and Klarna says it’s committed to approaching “global challenges with a sense of urgency and great optimism … to build a better future for everyone.” But really, BNPL is just another version of the same potentially risky consumer debt that has been around for ages. As Sen. Warren told the Prospect, “Buy now, pay later plans provide big banks and fintech companies with new schemes to trick and trap consumers, burdening them with costly loans they can’t afford.”

BNPL has found most traction with younger people and millennials. But the supposed affordability is what entices Americans on the lower end of the income scale to the service; 53 percent said they couldn’t have afforded their purchase otherwise. Black consumers are also most likely to use BNPL for affordability reasons, with 51 percent citing affordability, compared to 36 percent of white consumers who used the service.

In a 2019 interview, Afterpay’s CEO Nick Molnar recalled the malaise of young adulthood following the 2008 financial crisis. His generational cohort abandoned credit cards and other traditional lines of credit, and that’s where he saw his opportunity—not by genuinely innovating, but by slapping a glossy coat of paint on the same old lending as before.

“That’s the entirety of financial services. That’s the old Volcker comment, that there have been no good financial innovations since the ATM,” Georgetown law professor Adam Levitin told the Prospect. “These are still either credit or payment products, whether you access it from your phone or computer or a 3×5 card, it doesn’t make a huge amount of difference.” Regulators are scrambling to catch up to this old playbook dressed up with a new cover.