Reports show that millennial and Gen Z consumers increasingly use Buy Now, Pay Later products for everyday purchases like groceries, and that some consumers are strategically using it to preserve or inflate their credit scores.
Reports show that millennial and Gen Z consumers increasingly use Buy Now, Pay Later products for everyday purchases like groceries, and that some consumers are strategically using it to preserve or inflate their credit scores.03/14/2024 3:45 P.M.
6 minute read
The surge in Buy Now, Pay Later transactions—plus mounting data on how this lending tool is being used—has prompted a flurry of activity from financial services companies and regulators.
BNPL services through companies such as Klarna, Afterpay and Affirm are growing in popularity with consumers, who are attracted to the ability to make interest-free payments on a product or service. Recent reports have found that consumers turn to BNPL both out of necessity and convenience, with varying long-term results.
Who Uses BNPL?
Two in five U.S. consumers use BNPL services, according to Afterpay, with younger generations using it most frequently. Seventy-five percent of Gen Z and 74% of millennial BNPL customers say they use the service at least once a month, compared to 52% of Gen X customers.
Afterpay also reports that Gen Z and millennial users’ spending on travel and household items surpassed spending on apparel from 2022 to 2023, the top category until last year.
NBC News recently shared a story about a young consumer using BNPL products for staple purchases:
“Benjamin Espinoza, 27, recently stocked his fridge using a discount promotion from Instacart and selected Klarna at checkout, using the BNPL provider to spread out his roughly $40 bill. ‘It sucks that these are the avenues that I have to go through,’ said the San Antonio, Texas, video editor, who lives with three roommates. Espinoza said he made less than $7,000 last year after earning his bachelor’s degree in history two years ago. He acknowledged most BNPL services don’t help consumers build credit for timely repayment but said, ‘It’s good that it’s here in the moment.’”
The New York Fed found that BNPL purchases under $250 were among the most common for both financially fragile and finically stable households.
Consumers in financially fragile households are more likely to get financing through BNPL than in the traditional credit system as the loans generally offer better APRs and lower late fees, according to a series of briefings issued by LexisNexis. Those consumers are also “more likely to have derogatory events in their past, such as evictions, liens, bankruptcies or are highly leveraged and have missed payments.”
However, LexisNexis said it was surprised to discover that BNPL loans are also popular among consumers with near prime and prime credit scores, who would simply rather avoid using their credit card and accruing the related interest.
Credit Reports
While the major credit bureaus announced plans in 2021 to include BNPL loans on credit reports, their progress has been slow. The Office of the Comptroller of the Currency (OCC) pointed out that existing credit scoring systems aren’t designed to capture the short-term nature of BNPL loans.
Apple started reporting its BNPL loans—known as Apple Pay Later—to Experian this month, and Affirm reports some of its loans to Experian as well, “but across the industry, the vast majority of BNPL products remain unknown to credit bureaus,” according to a Bankrate article.
This lack of visibility into consumer behavior may obscure high-risk credit behaviors, making it challenging for lenders to assess applicants’ creditworthiness.
LexisNexis recommends lenders monitor BNPL usage and behaviors through alternative data sources to track risk migration.
Consumer Motivations
Many consumers like BNPL because it preserves their credit score. A Pymnts survey found that 19.4% of respondents indicated they were motivated to use BNPL to maintain their credit score, as the application often doesn’t necessitate a hard credit check.
In a brief, LexisNexis reported a correlation between frequent BNPL applications and higher credit scores, noting that untracked BNPL debt can contribute to inflated credit scores for consumers: “Regular and subprime users of BNPL had an average credit score increase of 12 points over a 12-month period. “
LexisNexis also found a net improvement to the delinquency status of subprime consumers and a decline in collections inquiries during periods of frequent BNPL use.
“While it is possible that credit scores increase because migrating from traditional credit to BNPL could hide risk, we see actual changes in credit quality over time in the form of paydown behavior,” LexisNexis reported.
Collection Insights
Ohad Samet, co-founder and CEO of TrueML, said in a recent Fintech Leaders podcast that while delinquencies in BNPL have risen lately, he thinks the industry is undergoing a normalization process rather than facing a crisis.
“When Buy Now, Pay Later saw its delinquencies go up, people [said] ‘BNPL is done.’ BNPL is not done—it’s just a higher turnover product that sees the delinquency come faster than a credit card, where people max out their balance and then they take 180 days to charge off,” he said.
Statista pointed out that the delinquency figures recently released by Affirm are lower than the aggregated U.S. credit card delinquency rates.
Samet’s debt recovery platform, TrueAccord, works with a lot of BNPL consumers and has found that as the product becomes a more significant part of consumers’ overall debt obligations and payment priorities, “the percent of BNPL customers who make a payment is more than double the like-size credit card accounts at 30 days post placement and 50% higher at 90 days.”
On average, BNPL customers are “digitally savvy” and prioritize lower balance accounts first when repaying their debt, TrueAccord observed. The company also found that “identifying and encouraging consumers who are motivated by regaining access to their BNPL service, using the correct combination of content and communication channel, increases repayment rates by 11%.”
Samet said on the podcast that he doesn’t see BNPL displacing credit cards in a meaningful way, but he does hope it displaces payday loans.
Regulatory Scrutiny
New York Gov. Kathy Hochul recently proposed legislation that would require BNPL lenders to obtain a license to operate in the state. She said in a speech that she wants to “to put stronger regulatory guardrails around the buy now, pay later loan industry.” The bill would grant the state’s Department of Financial Services authority to issue regulations for BNPL lenders.
A Bloomberg Law article noted that if the legislation is passed, New York would be the second state to enact a comprehensive regulation on BNPL lenders, after California.
While we haven’t seen any federal rules on BNPL yet, the Consumer Financial Protection Bureau is watching this sector closely. It said in 2022 that it was considering “interpretive guidance” for the industry and recently published a report noting that BNPL borrowers are more likely to exhibit measures of financial distress than non-users.
This activity, as well as the BNPL guidance recently released by the OCC, puts BNPL lenders on notice that regulators intend to address any perceived risks, said Max Bonici, counsel for Venable LLP.
“Following the bank failures last year, supervision in general—including for BNPL—has been cranked up quite a bit,” Bonici said. “Federal banking agencies like the OCC are going through bank balance sheets, and looking at what they do and how they do it with a very fine-tooth comb to find any risk that isn’t sufficiently addressed or is excessive.”
Bonici expects to see more oversight and scrutiny of BNPL in the near future. Not only that, but lenders may see a trickle down of some of these concerns even on a contractual basis. “Contracts might be a little more detailed and there will be a little more attention paid to practices,” he said.
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