How ‘Buy Now, Pay Later’ is changing consumer behaviour for the worse.
Ben Leacock
‘Buy Now, Pay Later’ (BNPL) is something that needs no introduction. It is everywhere, from the clothing brands, electronic stores, and food delivery apps we buy from. Vendors like Klarna, Afterpay, and Affirm have rapidly populated our checkout screens with an increasingly vast number of ways to pay. They offer point-of-sale, short-term, mostly interest-free loans that are much more accessible than the typical means of credit that we are all familiar with. While its benefits seem plentiful, we should be careful not to ignore any potential drawbacks of BNPL, such as increased spending and borrowing, which could lead to potentially worse financial health outcomes for consumers. This article seeks to explore the pros and cons of BNPL, taking into account recent literature analysing its effect on consumer behaviour, particularly focusing on its effect on financial health.
BNPL financing methods have taken the e-commerce market by storm, making up an estimated 5% of the market (around $300 billion) by transaction value in 2022. In the same report from the year prior, it was predicted that BNPL’s market share would reach 5% by 2025; its rapid growth rates have dramatically beaten expectations. Globally, point-of-sale financing is the fastest-growing unsecured lending product, outpacing credit card and personal loan borrowing.
On the one hand, BNPL availability can be used to cover needs, avoid sudden financial disruptions, lead to more stable financial situations for consumers, and hence improve the welfare of consumers by stabilising their financial situations. Furthermore, along with its convenience factor, BNPL users have been shown to choose BNPL primarily due to it being cheaper than all other options. A report by Bain & Company estimated that over the course of 2020, ‘people using BNPL in the UK saved £103 million in credit card interest costs.’ It therefore comes as no surprise that, according to the survey in the report, ‘only 8% preferred to use a credit card or overdraft when a BNPL option is available.’ In theory, BNPL could replace punishing, high-rate credit cards or personal loans, reaching and aiding a wider base of consumers who were previously without credit access and acting as an attractive substitute to those with credit access. One of the three largest consumer credit reporting agencies, Equifax, has released a report showing that, ‘individuals with either a “thin” credit file consisting of two or less tradelines or a “young” credit file — where all credit history is no more than 24 months old — saw an average FICO credit Score increase of 21 points with the addition of on-time BNPL tradelines to their credit file.’ The report further found that ‘BNPL can also help consumers rebuild their credit. Consumers who had significantly late payments reported on their traditional credit file experienced an average FICO Score increase of 13 points with the addition of on-time BNPL tradelines to their credit file.’
However, growing evidence points towards the negative effects of BNPL on consumer behaviour. Cheap credit has long been observed to lead to higher levels of consumption and worsened financial health. Crucially, new BNPL users have been shown to, ‘experience rapid increases in bank overdraft charges and credit card interest and fees, as compared to non-users’. Di Maggio, Katz, and Williams (2023) corroborated this phenomenon and further described a model they call the ‘liquidity flytrap effect’. This effect attempts to describe why there is a substantial, persistent increase in the share of spending on retail goods associated with the availability of BNPL. They conclude that this persistent shift in the retail share of spending is, ‘consistent with individuals coding repayments as part of a different mental budgeting account’. They end the paper noting how traditional models, ‘do a poor job of quantitatively capturing the consumer response to emerging “PayTech” platforms’ and that, ‘This may call into question whether qualitative patterns in the data, such as increased spending or more smooth expenditures, imply genuine welfare improvements as they are assumed to in existing models.’
When further inspecting the characteristics and financial health of BNPL users, the story becomes darker. Recent data looking at US consumer financial health by the Consumer Financial Protection Bureau shows that the delinquency rates (i.e., the percentage of loans or credit accounts on which the borrower has failed to make payments on time) for BNPL users are significantly higher on every typical credit product than non-BNPL users (see Figure 1). Additionally, BNPL users typically have higher open account rates than non-users, which matches the finding in a survey of 1,862 US consumers that found that 14% of BNPL users use BNPL because they have maxed out their credit cards. However, this figure seems to vary a lot from survey to survey, with a more recent report having this figure at 33%.
Putting it into a wider context, when looking at Klarna users in the US and US consumer debt, it is clear that the growth of Klarna is part of a wider acceleration in borrowing by US consumers.
Another way we can observe the impact BNPL is having on consumers is by looking at surveys on how it is affecting their spending and, hence, their financial health. A Barclays survey of 2,000 UK consumers found that, ‘18-24-year-old consumers who use BNPL products spend 20% of their discretionary income on repayments.’ The survey further found that 68% of 18-24-year-old users of BNPL products have accrued debts across multiple providers simultaneously, with 59% of those users having debts with three or more providers. Several other surveys have yielded similar findings to different degrees, indicating that individuals with the lowest incomes in the younger demographic are particularly susceptible to excessive spending through BNPL, acquiring multiple lines of credit with BNPL providers, and experiencing difficulty in managing BNPL payments.
Looking at it from a business perspective, BNPL providers have strong incentives to overprovide (relative to the consumers best interests) BNPL products to consumers, as they make the vast majority of their revenue from commissions from point-of-sale purchases on retail sites with BNPL. This is not to say that BNPL providers will want to over-provide until the point where consumers cannot make repayments, which is obviously not ideal. And they have measures to make sure non-paying users are quickly punished and cut off if necessary. However, nothing is stopping the overprovision of BNPL products in their current unregulated form. Consumers are overspending on retail transactions, regretting their purchases, opening up accounts with multiple BNPL vendors (known as ‘loan stacking’), and falling behind on their payments, without mentioning the further knock-on effects on their other traditional credit products, such as increases in bank overdraft charges and credit card interest and fees, as mentioned before.
We should not overlook the positive changes BNPL is bringing to the world of consumer credit. Interest-free loans and minimal financial background checks mean that credit is cheaper and more accessible than ever. However, growing concerns over its effect on consumer behaviour and financial health have led to a consensus that at least some regulation is required. In the UK, draft government proposals have been created to grant the Financial Conduct Authority (FCA) broad powers to regulate and even ban BNPL vendors from further lending. Ideally, the FCA would be able to hone in on the overextension of lending by requiring more thorough affordability checks while still keeping the sector competitive and maintaining cheap credit for consumers. In the absence of robust regulation in most countries globally, industry stakeholders and policymakers must come together to strike a balance between providing accessible credit products and safeguarding consumers from potential harm, because if done right, BNPL has the transformative potential to revolutionise and redefine the landscape of consumer finance for generations to come.