Cyber Monday: The hidden debt of buy now, pay later

Online spending on Cyber Monday hit a record $13.3 billion. The number retail finance analysts noticed was smaller: close to $1 billion of it was paid for with 'Buy Now, Pay Later' (BNPL) plans, the most ever for deferred consumer credit.

How pay-in-four works

The standard BNPL product splits a purchase into four equal payments, the first at checkout and the rest every two weeks, with no interest if the shopper pays on time. The lender, whether Affirm, Klarna, Afterpay or PayPal, earns most of its money from the merchant, which pays a fee usually higher than the cost of accepting a credit card in return for bigger baskets and fewer abandoned carts. Late fees and longer interest-bearing plans make up the rest. For the shopper the appeal is plain: a gift paid for in instalments with no visible cost of credit.

Debt the bureaus miss

The heavy use of short-term instalment loans points to strain in middle-class household budgets. With credit card rates above twenty-two per cent, shoppers are turning to lightly regulated point-of-sale loans to pay for ordinary holiday gifts. Most BNPL debt does not show up at the traditional credit bureaus, so American consumers probably owe more than the official figures say.

The gap matters for lending decisions as well as for statistics. Because pay-in-four loans are mostly absent from credit files and scoring models, one BNPL lender cannot see what a shopper owes to another, and a borrower can open several plans across different apps in the same week. Card issuers and mortgage lenders assessing that household see only part of its obligations. Official measures miss the borrowing too, including the New York Fed's quarterly household debt report, which showed credit card balances passing $1 trillion for the first time last year.

The borrowers are not a random sample of shoppers either. Research published by the Consumer Financial Protection Bureau last year found that BNPL users were, on average, more heavily indebted than non-users, with higher card balances, lower credit scores and a greater tendency to have fallen behind on other loans. The product appeals most to the households least able to absorb a missed payment.

Who holds the risk

The loans do not stay on the lenders' books for long. The specialist providers fund themselves by borrowing from banks against their receivables, packaging loans into asset-backed bonds and selling pools of them to outside investors, including private-credit funds. That model lets them grow quickly without much capital of their own, and it means rising arrears would spread beyond the apps to the bond buyers and funds that bought the loans. The sector is also courting public investors: Klarna said last month that it had filed confidentially for a stock-market listing in New York, and a rise in losses during the holiday repayment season would be awkward timing.

The industry has shaken out already. Apple closed its own pay-later service in June, folding the feature into partnerships with established lenders, which left the market to specialists and PayPal. Consolidation concentrates the risk in fewer hands but does nothing to make it more visible to anyone else.

Regulators are half in

The Consumer Financial Protection Bureau moved in May to treat BNPL lenders like credit card providers under the Truth in Lending Act, giving borrowers rights to dispute charges and claim refunds. The rule does nothing about credit reporting, and its future is uncertain under an incoming administration that has promised to cut back federal regulation. For now the sector sits in a grey zone, supervised more lightly than card issuers while doing much of the same job for many of the same customers.

Other countries have moved further. Britain's government has promised legislation to bring BNPL lending under the Financial Conduct Authority, with affordability checks before a loan is granted, and Australia has passed a law treating the products as regulated credit. American rules still leave the question of whether a borrower can afford a plan largely to the lenders themselves.

A benign reading

The strongest counterargument is that BNPL is a cheaper substitute rather than a sign of distress. A shopper who pays four interest-free instalments instead of carrying a card balance at those rates is making a rational choice, and many users have good credit and use the plans to smooth their budgets. The loans are small and short, and the sums involved are modest next to the card market. That holds for disciplined borrowers. The trouble lies with those who stack plans across several providers, and the reporting gaps mean nobody, lenders included, can yet see how many of them there are.

When the bills fall due

The repayment schedule makes the timing easy to predict. Plans taken out over the Thanksgiving weekend fall due in instalments through December and into January, the same weeks that card statements for holiday spending arrive and before most households receive tax refunds. Missed payments would show first in the providers' own results and in card delinquency rates, which the New York Fed will next report early in the new year. Retailers that pushed the option hardest at checkout may find that some of this season's sales were made to shoppers who cannot repay on time.

Record BNPL use shows how much of this holiday season was bought on credit. The bills fall due in the new year, and lenders and retailers could see the damage in rising arrears by the spring. The households most exposed are those already carrying card balances at more than twenty-two per cent, and the first place their strain will show is in late fees on pay-in-four plans that were sold as free.