Americans may have to pay a lot later for 'phantom debt'
“Buy now, pay later” loans are helping fuel the record-setting holiday shopping season. Economists worry they could hide and exacerbate cracks in Americans' financial well-being.
Loans, which allow consumers to pay for purchases in installments, have grown in popularity due to their often interest-free, high prices and interest rates. Retailers use them to attract customers and motivate people to spend more.
But according to consumer groups and some lawmakers, such loans could encourage young and low-income Americans to take on too much debt. And because such loans are not regularly reported to credit bureaus or recorded in public data, they may also represent a hidden source of risk to the financial system.
Wells Fargo economist Tim Quinlan recently published a report describing later-paid loans as “phantom loans,” saying, “The more I delve into it, the more I am worried.”
Traditional measures of consumer credit indicate that overall US household finances are relatively healthy. But, Mr. Quinlan said, “If they're losing the fastest-growing part of the market, those assurances are worth nothing.”
Estimates of the size of this market vary widely. Mr Quinlan believes spending through post-payment options this year was about $46 billion. That's relatively small compared to the more than $3 trillion that Americans carried on their credit cards last year.
But such loans offered by companies like Klarna, Affirm, Afterpay and PayPal have grown rapidly. The increase comes at a time when the financial situation of some Americans is beginning to show early signs of stress.
Credit card lending is at a record high in dollar terms – though not as a share of income – and delinquencies are rising, despite being low by historical standards. This stress is especially evident in young adults.
According to the Federal Reserve Bank of New York, people in their 20s and 30s are by far the biggest users of payday loans. This may be a sign of financial problems – young people may end up using pay-as-you-go loans after maxing out credit cards – and may also be a reason to encourage them to overspend.
Liz Cisneros, a 23-year-old college student in Chicago who works part-time at Home Depot, said she was surprised by the ease of the pay later programs. During the pandemic, she saw influencers on TikTok promoting the loan and a friend said it helped her buy designer shoes.
Ms. Cisneros began using it to buy clothes, shoes and Sephora beauty products. He often had several debts at the same time. While standing in the grocery checkout line she didn't have enough money when she realized she was overspending. A pay-letter company had withdrawn funds from her bank account that morning and she had failed to keep track of her payment schedule.
“It's easy when you keep clicking and clicking and then it's not easy,” she said, when she realized she had spent too much.
Ms. Cisneros said the problem was especially acute around Christmas, and this year she was not shopping for the holidays so she could pay off her debt.
Pay-as-you-go loans became available in the United States years ago, but declined during the pandemic as online shopping increased.
The products are somewhat similar to layaway programs offered by retailers decades ago. Online shoppers can choose the pay-later option at checkout or on the pay-later companies' apps. Loans are also available at some physical stores; Affirm said Tuesday it has begun offering pay-later loans at self-checkout counters at Walmart stores.
The most common loans require buyers to pay one quarter of the purchase price upfront and the rest in three installments, usually over six weeks. Such loans are generally interest-free, although users sometimes have to pay a fee. Pay later companies make most of their money by charging retailers fees.
Some lenders also offer interest-bearing loans with repayment terms that can last from a few months to more than a year.
Pay later companies say their products are better for borrowers than credit cards or payday loans. He says that by offering smaller loans, they can better assess borrowers' ability to repay.
“We are able to identify and make loans to consumers who have the ability and willingness to pay more than revolving credit accounts,” Michael Linford, Affirm's chief financial officer, said in an interview.
In its most recent quarter, 2.4 percent of Affirm loans were 30 days or more delinquent, down from 2.7 percent a year earlier. Those numbers don't include its four-payment loan.
Klarna chief executive Sebastian Siemiatkowski said the service is most useful for certain purchases, such as buying an expensive sweater that will last for several years.
Paying later for frequent purchases like groceries probably makes less sense, he said, although Klarna and other companies make their loans available at some grocery stores.
Mr Siemiatkowski acknowledged that people could abuse his company's loans.
“Obviously it's still credit and so you'll find a subgroup of individuals who unfortunately are not using it the way they're intended,” said Mr. Siemiatkowski, who founded Klarna in 2005. He said the company tried to identify those users and deny them loans or impose strict conditions on them.
Stockholm-based Klarna says its global default rates are less than 1 percent. In the United States, more than a third of customers repay loans early.
Kelsey Greco made her first payday purchase for a mattress about four years ago. Paying $1,200 in cash would have been difficult, and making the purchase on a credit card seemed foolish. So he got a 12-month interest-free loan from Affirm.
Since then, Ms. Greco, 30, has regularly used Affirm, which also includes a Dyson hair tool and a car brake. Some loans charged interest, but she said she still preferred this form of borrowing because it was clear how much she would pay and when.
“With a credit card, you can swipe it all day and say, 'Wait, what did I get myself into?'” said Ms. Greco, a Denver resident. “Whereas with Affirm, it's giving you these clear numbers where you can see, 'Okay, this makes sense,' or it doesn't make sense.”
Ms. Greco, who was introduced to The Times by Affirm, said pay-after loans helped her avoid the credit card debt that had previously plagued her.
But not all consumers use the pay later option carefully. A Consumer Finance Protection Bureau Report This year found that about 43 percent of paid-later users had overdrawn a bank account in the past 12 months, compared to 17 percent of non-users.
“This is a more vulnerable part of the population,” said Stanford University researcher Ed DeHaan.
one in paper published Last year, Mr. DeHaan and three other scholars found that within a month of first using a pay-later loan, people became more likely to experience overdrafts and accrue late fees on credit cards.
Financial advisors who work with low-income Americans say more clients are using pay-later loans.
Barbara L., a financial advisor in Chicago. Martinez, who works at Heartland Alliance, a nonprofit group, said many of her clients used cash advances to cover loans they paid off later. When the paycheck comes, they don't have enough to cover the bills, forcing them to turn to pay-later loans.
“It's not that the product is bad, but it can get out of control very quickly and cause a lot of damage that could have been prevented,” he said.
Brianna Gordley learned about pay-later products in college. She was working part-time and couldn't get approved for a credit card, but pay later providers were eager to boost her credit. When her working hours were reduced, she started falling behind. Eventually, family and friends helped him pay off the loan.
Ms. Gordley, who Testified about your experience He now works on consumer finance issues for Texas Appleseed, a progressive policy organization, at a listening session held by the Senate last year. He said pay-later loans could be an important source of credit for communities that lack access to traditional credit. She still uses them occasionally for larger purchases.
But he said companies and regulators need to make sure borrowers can afford the loans they are taking. “If we're going to be making these products and building these systems for people, we just have to have some checks and balances.”
The Truth in Lending Act of 1968 requires credit card companies and other lenders to disclose interest rates and fees and offers various protections to borrowers, including the ability to dispute charges. But the Act applies only to loans with more than four payment installments, effectively excluding loans with multiple subsequent payments.
Many such loans are not even reported to credit agencies. As a result, consumers can get multiple loans with Klarna, Afterpay and Affirm without the companies knowing about other loans.
“It's a huge blind spot right now, and we all know it,” said Liz Pagel, TransUnion's senior vice president who oversees the company's consumer lending business.
TransUnion, other major credit bureaus as well as post-payment companies all say they support more reporting.
But there are practical obstacles. The credit-rating system gives borrowers higher rates for longer-term loans, including long-term credit card accounts. Each pay-later purchase qualifies as a separate loan. As a result, those loans can lower borrowers' scores, even if they repay them in full and on time.
Ms. Pagel said TransUnion has created a new reporting system for the loans. Other credit bureaus like Experian and Equifax are doing the same.
Pay later companies say they are under-reporting fewer loans, especially those with longer tenures. But most are not reporting and will not commit to reporting loans with only four payments.
That worries economists who say they are particularly concerned about what effect such loans will have when the economy weakens and workers begin to lose their jobs.
Marco Di Maggio, a Harvard Business School professor who has studied pay-later products, said that when times were tough more people would use such loans for small expenses and get into trouble. “You only need one more shock to push people into default.”