Why “buy now, pay later” companies are under government scrutiny

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  • Buy Now, Pay Later services have exploded in recent years, and the government is trying to catch up.
  • The Consumer Financial Protection Bureau launched an investigation into the sector last month, citing debt problems.
  • According to experts, the rapid growth and popularity of businesses among young buyers leads to a series of credit risks.

Americans — and primarily Gen Zers — are increasingly turning to Buy Now, Pay Later (BNPL) services for instant gratification and deferred payment.

This sounds the alarm of the risk of indebtedness in Washington.

Services basically do what they say on the tin. Buyers using BNPL take out short-term, often interest-free loans to pay for their purchases and sign a scheduled repayment plan to pay off the debt.

But the growing popularity of the services has raised concerns about how much debt these BNPL firms are allowing to take on and how quickly it is happening. Additionally, a lack of oversight has also clouded whether the loan is safe or potentially the basis for a wider financial mess.

The companies in question do not just distribute free money on the Internet. Participating companies pay a small fee to BNPL services for the additional activity – but the details of these terms and consumer disclosures are murky.

BNPL led to a boom in spending and debt in the era of the pandemic

BNPL services emerged before the pandemic, but the health crisis lit the fuse for their explosive growth. Businesses exploded as people stuck at home moved their shopping online. The option is most popular with younger consumers, with 61% of Gen Z having used a BNPL service before, according to a March survey by The Ascent.

This meteoric rise has raised concerns among regulators about the level of debt risk BNPL could create. The Consumer Financial Protection Bureau has launched an investigation into BNPL companies, including Affirm, Klarna and Afterpay December 16, citing concerns about debt growth, data collection and consumer disclosures. Since services do not yet face the same regulations as other forms of borrowing, they present new risks of a possible credit bubble, according to the agency.

“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 also gets the debt immediately,” said Rohit Chopra, director from the office, in a press release.

The debt pile could be huge. Cornerstone Advisors estimates that BNPL purchases totaled nearly $100 billion in 2021. That’s up from just $24 billion the year before. Separately, CB Insights projects, the global BNPL industry could top $1 trillion in annual volume as early as 2025.

Gen Z could face a debt cliff

The main users of BNPL represent perhaps an even greater risk. The services have been successful in attracting a younger audience who “might not be creditworthy or have a lot of experience with traditional types of credit,” Marisabel Torres, director of California policy at the Center for Responsible Lending, told Insider.

Gen Z are also the most likely to be caught off guard when student loan repayments are set to resume in May. The older members of the generation spent more time after graduation with their payments frozen than not due to the federal government’s pandemic moratorium. The May 1 deadline could be “concerning” for those who cannot balance their student loan obligations with late BNPL payments, Torres said.

It’s not just government officials catching up with the BNPL boom. Credit rating agencies including Equifax and TransUnion are still working on adding BNPL debt to their reports and aim to start services in the coming weeks. American banker reported earlier in January.

Companies are probably not too late to catch a major bubble, but their slowness is concerning, especially with the financial crisis still a recent memory, Susan Sterne, president and chief economist at Economic Analysis Associates, told Insider.

“The big three agencies that track consumer debt haven’t really gotten their hands on it yet because it’s a relatively new concept,” Sterne said. “They were diligent after the financial crisis, but I guess nothing changed. They should have been more aware of that.”

Fine print could trip up borrowers

The CFPB investigation represents a “great first step,” but the BNPL industry needs more transparency if it is to continue growing at its current pace, Torres said. Regulations can put in place new protections so that buyers are not hampered by the differences of each service. Even something as simple as returning an item can be confusing and put buyers at risk, Torres said. Where people can expect a refund within a certain number of days with a traditional purchase, these guidelines do not exist for BNPL purchases. One service might require someone to repay the remainder of their loan, while another might only repay the amount repaid.

The complications of returning items are just one example where the law has not caught up with the industry. The longer the government waits, the more likely buyers will fall into the gaps between existing regulations, Torres said.

“We flooded the market with all this credit and nobody followed what was going on,” she said. “Unfortunately, if it sounds too good to be true, it might be. It’s not always the free financing option it’s marketed for.”

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