Americans are finding it hard to dig themselves out of debt, and a new research report suggests that the rising popularity of buy now, pay later could push those already struggling into a worse situation.
Financially fragile consumers — defined as those who have a credit score under 620, fell delinquent on a loan, or were declined for a credit application in the past year — were nearly three times as likely as financially stable consumers to use buy now, pay later (BNPL) five or more times last year, according to new research from the Federal Reserve Bank of New York.
Financially vulnerable households were also more prone to rely on the short-term installment loans at a higher frequency to afford smaller, unexpected expenses.
The findings come as millions of Americans struggle under the weight of mounting credit card debt and stubborn inflation, with young adults already finding it hard to pay bills on time. It also raised concerns about how broad access to BNPL — which remains largely unregulated — could cause those already struggling to make ends meet to overextend themselves.
“We can’t dismiss the potential risks of overextension, where frequent use of BNPL funding leads to excessive debt accumulation over time,” New York Fed researchers wrote in a Liberty Street Economics blog post.
How buy now, pay later services work
Buy now, pay later services, also known as point-of-sale installment loans, are essentially short-term loans with fixed payments.
Consumers can use BNPL either online or in-store through select retailers that accept these payment methods. Major chains, including Walmart (WMT), Amazon (AMZN), and Trader Joe’s along with hundreds of other retailers offer BNPL at checkout. Customers simply download the app of the BNPL service at time of purchase — Affirm (AFRM), Klarna, Afterpay, and PayPal (PYPL) are popular ones — and the service provides details of payment terms.
For example, if you want to purchase a vacuum from Costco (COST), you’ll have to disclose the amount you want to spend, and the BNPL company will give you a preapproved spending limit for the item. Borrowers can then make a payment through a virtual card in-app to pay for online or in-store purchases.
Unlike credit cards, which charge interest on revolving credit, most BNPL apps offer no-interest loans as long as you break down payments over six weeks or four equal payments.
In some ways, BNPL can be a great alternative to credit cards without dinging your credit. Most servicers only conduct a soft credit check for their popular “Pay in 4” loans, meaning your credit won’t take a hit.
“There’s an opportunity for some Americans who are undercredited, who have less access to credit to get access to BNPL so they can pay in installments,” Michael Hershfield, CEO of Accrue Savings, told Yahoo Finance. “Particularly, millennials and Gen Z generations who may have seen their parents or generations before them burdened by credit card debt, can engage in credit in a different way that’s not a credit card. That’s a positive.”
Still, there are risks associated with BNPL.
For one, longer-term BNPL loans can carry APRs as high as 36%.
For instance, if you were to purchase a tablet priced at $544 using Affirm, a payback period of 12 months at 25% APR would accrue $76.45 in interest. Meaning your estimated total would increase to $620.45 — a hefty total similar to what you might pay if you’d used a credit card.
In addition, some of the major BNPL players still aren’t reporting to the national credit bureaus Equifax, Experian, and TransUnion. That could create a blindspot to banks, particularly if someone at risk of overextending themselves applies for a credit card down the line.
“It potentially creates a lot of risk on the American consumer, because they might be double dipping on both their credit card debts and using BNPL to pay for things they may not be able to afford,” Hershfield said. “If it’s just replacing credit cards, then it’s no problem, but if it’s compounding the use of credit on Americans that’s a real negative signal to the US economy.”
So far, Affirm is the only servicer reporting some repayment activity and loans to Experian. However, BNPL servicers generally don’t appear on credit reports meaning any on-time payments won’t help you build credit.
While failure to pay on time won’t hurt your credit if your BNPL servicer isn’t reporting your activity to the credit bureaus, any overdue amounts sent to collections will.
Heightened use among those financially vulnerable
Buy now, pay later services have grown in popularity over recent years, with consumers finding offerings of the short-term installment loans virtually everywhere — from retail and grocery stores to major airlines.
But the use of BNPL for items as common as groceries, which now cost 25% more than they did in 2020, indicates that Americans’ personal finances are in trouble. In fact, among consumers who used BNPL during summer 2023, some 56% said they used the payment to buy groceries, a survey of 3,100 consumers from PYMENTS found.
Nearly 60% of financially fragile households used BNPL more than five times a year, compared to just 23% of financially stable consumers, according to NY Fed researchers. Almost 30% of financially vulnerable consumers ended up financing through BNPL 10 or more times, versus 10% of those financially better off.
Purchase sizes also differed among these groups.
While both groups leaned toward smaller purchases, a majority of financially fragile consumers had an average purchase under $250, while financially stable individuals were more likely to use BNPL to finance bigger purchases between $1,750 and $2,000.
“More fragile households tend to use the service to make frequent, relatively small, purchases that they may have trouble affording otherwise,” New York Fed researchers wrote.
Though the ability to pay off small purchases over time at no interest is a better option than other financing options like payday loans, the NY Fed findings suggest that BNPL is ensnaring vulnerable consumers the same as those other products.
Since BNPL lenders aren’t subject to regulation the way credit card issuers are, this could cause younger people to “normalize” debt accrual, warned the Consumer Financial Protection Bureau (CFPB). Consumers could also be forced into auto-payments or have less protections should they want to dispute a fee, for example.
A separate analysis from the North Carolina Banking Institute found that BNPL could utilize customer data to tailor appealing products specific to the consumer through apps. That could make it harder for consumers to disengage from using their services, especially as BNPL has become so widely accessible.
“Consumers need to be cautious,” Hershfield said. “If they are overextending themselves, it may look cheaper if you have four payments of $30. But they should ask themselves, can I afford to pay this over the next four payments without getting caught up in an inability to pay?”
Trouble down the road
Though BNPL services were offered to consumers of all age groups, those who actually ended up using these loans tended to be younger. Some were as young as 15 years old, a separate analysis from the NY Fed found.
However, the majority of financially vulnerable folks who used BNPL were those between the ages of 30 and 50.
For this group in particular, the resumption of federal student loan repayment is yet another pressure point on their finances.
When BNPL users were asked if they could come up with $2,000 in the next month in case of an emergency, only about half said they could. Additionally, only 42% said they could use savings to meet emergency costs, while the remaining share said they would have to rely on borrowing from friends, family, banks, or credit cards.
“Our evidence substantiates to some extent a concern expressed by some BNPL critics, that BNPL may attract consumers who already have financial difficulties and are struggling to pay their existing bills and debt payments,” New York Fed researchers wrote.
Another concern highlighted by the NY Fed is that BNPL could be enabling consumers to spend or borrow more than they should. A separate study revealed that individuals often spent 20% more when using BNPL products.
