Credit card companies (CCCs)—gigantic enterprises generating trillions of revenue dollars—helped popularize the notion that it’s easy to spend money you don’t have. Once consumers saw it was a lifestyle reality, they took to it like ducks to water.
Traditionally, the CCCs introduce new customers to credit card dependency with a year and a half of zero interest on the debt balances recorded (i.e., under or up to the allocated credit limit). Aligned with the latter are low minimum payments every four weeks. However, once the eighteen-month-zero-interest initiation period elapses, the shock of 19 – 29% APRs instantly bursts the cardholders’ bubbles. By then, they’re deep in red ink and have little choice but to service the top-heavy loans with little to no leverage left for shopping. Moreover, once locked into the CCCs, debit balances can go as high as $40,000 per card, with exorbitant rates draining customers’ resources and no fast resolution to the dilemma.
So around 2010, fintech entrepreneurs entered the consumer-lending arena with strategies to disrupt the CCC’s market domination. They categorized their activities as “Buy Now, Pay Later,” or BNPL. Indeed, companies such as the Swedish organization Klarna, Zip, Affirm, PayPal’s spinoff Pay-in-four, and Afterpay (to name a few) offered the buying public the somewhat startling benefit of credit with zero-interest payment plans. Right away, BNPL stood out as a compelling value proposition diametrically opposed to CCCs, thus attracting attention from the word go.
How did they do it? By partnering with retailers across thousands of brands and a broad range of industries—everything from Peloton bikes to electronics, furniture, apparel, jewelry, and more. All frustrated CCC users had to do was download the applicable BNPL apps for access to paying cards, and voila! They were back into buying mode for small and big-ticket items without a credit check (or a soft one at best). Consequently, even individuals with lousy FICO scores and a sketchy CCC history got in on the act.
How big is Buy Now Pay Later?
According to a LendingTree poll, nearly 42% of America’s buying population jumped on the BNPL bandwagon—a 25% jump in 2022 versus 2021. Also, the global BNPL market should generate $22.86 billion in 2022, estimated to reach $90.51 billion by 2029—an eye-popping 21.7% compound annual growth rate (CAGR). And it’s all thanks to Gen Z and Millennial BNPL opinion leaders.
In short, the BNPL revolution has hit consumer spending habits spot on, not as a one-night stand but as a sustainable alternative to CCCs. One can go so far as to say it’s a mainstream juggernaut that has redefined online and brick-and-mortar shopping. But, of course, the big question around all of this is whether or not the shift to BNPL carries hidden consumer risks.
Comparing BNPL and CCC for transparent risk evaluation
Not surprisingly, understanding the risks behind BNPLs begins with assessing CCCs’ lending and making relevant comparisons. Why is that necessary? Because if a service category emerges claiming to be a market disruptor (as is the case here), the usurpers’ pluses should far outweigh the minuses. As we’re talking financing, risk is the best viewfinder. So here we go:
- Interest fees:
CCC’s distinctive risk factors are that credit card debt may impose hefty interest rate fees if overspending leaves borrowers with challenging debit balances after the honeymoon period (i.e., usually twelve to eighteen months).
For BNPLs, none of these extra charges enter the picture, especially during the extended return period.
- Transaction charges
CCCs rely on their revenue from two sources—merchant charges and card users.
BNPLs rely only on retailers to pay transaction commissions (anything from 2 – 6%) unless exceptional circumstances arise (see below.)
- Credit rating
CCC application ties in closely to one’s credit rating to qualify for a credit card in the first place.
BNPLs mainly do not rely on credit score overviews, and instead do a minority soft-check of FICO scores.
It seems like BNPL is a no-brainer, right?
Who in their right mind would opt for a credit-score-centric loan with double-digit interest hanging over one’s head versus the alternative with no pack drill entry and redeeming principal only? However, there’s much more to it than meets the eye once we dig a little deeper. The following contrasts highlight a few concerning risks for BNPL users:
Credit Card Companies
Credit card debt accumulates from multiple merchants selling goods and services to the cardholder using a single card, with no formal redemption period for any one entry. Thus, we have myriad unpaid transactions adding up over time, resulting in a substantial long-term debt specific to that card.
For example: Imagine Consumer X making a hundred transactions (e.g., with restaurants, supermarkets, Costco, Home Depot, and CVS, etc.) over six months, averaging $100 per entry on an AMEX card.
The total tots up to $10,000 in the first cycle (interest-free).
The cardholder pays AMEX the monthly minimum of approximately $500 monthly.
Thus, after half a year, Consumer X registers a debt on the card of $7,000.
Loving the experience with a $22,000 credit limit, Consumer X repeats the cycle twice more, paying only the minimum and reaching the one-and-a-half-year mark with net debt of $21,000, triggering a 19% annual interest rate starting in month nineteen.
From then on, Consumer X’s $500 “monthlies” must cover $332 interest, and the shopping spree is all but done (unless there’s a capital redemption over and above).
Buy Now Pay Later
BNPL debt accumulates differently from Consumer X’s experience, as described. Instead of one card, let’s assume Consumer Y deals with various retailers’ selected BNPL partners, thus spreading 100 purchases across multiple payment apps, with a strict and formal installment schedule for each entry per relevant app. Consequently there is a range of BNPL debt totals across multiple apps, all payable in the short term.
For example: Imagine Consumer Y entering 100 BNLP transactions over six weeks, with an average of $100 per entry. Of course, BNPL providers may partner with several retailers in Consumer Y’s ambit.
Thus, the total is $10,000 over, say, 10 apps, equalling approximately $1,000 per app.
However, each debt has a repayment deadline built around four installments for complete redemption within three months of initiation.
As the months roll by, installments become compulsory. Therefore, Consumer Y is under pressure to settle $10,000 of debt at around $3,300 per month. As long as Consumer Y complies, all parties are happy.
Unfortunately, Consumer Y loses control of the breadth of the transactions and the number of apps involved. Simply put, $3,000 monthly is unaffordable.
Bottom line, the best Consumer Y can do is redeem $2,000 of the $10,000, or 20% of the BNPL loans outstanding, within the compulsory timeframe.
As a result, late payment penalties kick in, and double-digit interest rate charges enter the equation on the delinquent debt. Sometimes, the BNPL providers report the delinquency to credit agencies.
Comparing Credit Card versus Buy Now Pay Later
So, reviewing the above side-by-side, we can conclude the following:
- It’s all a loan:
A loan is a loan in the CCC and BNPL respective arenas, and both have severe consequences if the borrowers lose control of their budgets.
In both instances, it comes down to only making the transactions one knows are repayable to avoid onerous financing charges.
- Faster interest time frames for BNPL:
Indeed, undisciplined control on BNPL apps can turn out worse, with interest burdens entering the mix in months three or four (versus eighteen months for CCCs).
- BNPL more transparent:
The one advantage of BNPL is that they are more in the consumer’s face about obligations, emphasizing the near-term settlement aspect at every term.
- An analogy perhaps best explains the comparison:
Mismanaged credit cards are like slow leaking roofs that contaminate ceiling material, only noticeable long after the leak when the latter’s rot appears.
BNPLs acquired without planning are like a massive flood of water that almost simultaneously pours through the ceiling.
More cons to consider
Ironically, a significant complication to the matter is BNPL’s phenomenal growth and success. Why? Because, with new fintech providers popping up daily to capitalize on the burgeoning marketplace, it becomes more enticing for consumers to access BNPL loans and sign up for an array of small purchases.
For example, even Apple has entered the BNPL field, first for its own product customers via Apple Card with zero-interest payment plans. Second, they launched “Apple Pay Later” to extend funding consumer transactions for all brands (even Samsung, an arch competitor) aligned with Apple Wallet. The default agreement of the latter is four payments over six weeks.
Thus, multiple BNPL options streaming through makes it challenging to rely on one’s rational thinking to keep the loan applications under budget. Indeed, looking at the data, it’s sometimes a “honey trap”:
- Did you know that 42 % of BNPL consumers have slipped on at least one payment?
- Believing it’s no big deal because you’ll get back on track is a cardinal error. Frequently, all it takes for BNPL providers to allot ongoing interest charges to an errant borrower is a single misstep that they traditionally won’t reverse.
So, it brings us to the next whopper working against BNPL: a singular lack of essential due diligence. Unfortunately, very few customers look into the agreement terms beyond the installment value and expected schedule. That can be a devastating error, considering every provider has a different lending policy. Some even start off charging a token APR. Therefore, borrowers need to know the implications of late payments, which generally introduce substantial interest charges and possible reports to credit agencies.
Evaluating Buy Now Pay Later for customers
We’re not advocating that every BNPL customer is a loose cannon or that the industry is in the same boat as the delinquent CCC scenarios described above, just with a different oar. Hopefully, the majority will approach the BNPL revelation conservatively and stay within budget.
However, our focus is on consumer risks and market perceptions of the same. Not only will this give consumers an insight about which financing option they might prefer, but it will also help businesses determine which payment methods they would be wisest to incorporate.
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