Soaring Popularity of Pay-Later Loans
Companies such as Klarna, Affirm, Afterpay, and PayPal have experienced rapid growth in the provision of pay-later loans. While credit card borrowing is at a record high in dollar terms (although not as a share of income), delinquencies are also increasing. The Federal Reserve Bank of New York reports that individuals in their 20s and 30s are the primary users of pay-later loans. This indicates both potential financial struggles, as they may resort to pay-later loans after maxing out their credit cards, and a possible cause of such struggles as the loans encourage excessive spending.
Liz Cisneros, a 23-year-old college student in Chicago, shared her surprise at the ease of using pay-later programs. Influencers on TikTok promoting these loans and a friend’s positive experience influenced her decision to use them for purchases such as clothes, shoes, and beauty products from Sephora. However, Ms. Cisneros acknowledged the dangers of overspending and has taken steps to pay off her debts rather than shop excessively during the holiday season.
The Rise and Availability of Pay-Later Loans
Pay-later loans have been available in the United States for several years, but their popularity surged during the pandemic, coinciding with a significant increase in online shopping. These loans are not limited to online retailers; Affirm recently announced its introduction of pay-later loans at self-checkout counters in Walmart stores. The most common form of these loans requires buyers to make a quarter of the purchase price as an upfront payment, with the remainder paid in three installments over a six-week period. Some lenders offer loans with interest, featuring repayment terms ranging from a few months to over a year.
Promoters of pay-later loans argue that their products are more favorable for borrowers compared to credit cards or payday loans. They claim that by offering shorter loan terms, they can better assess borrowers’ repayment capability. Affirm’s chief financial officer, Michael Linford, emphasized their ability to identify and extend credit to consumers with a higher willingness and capacity to repay than revolving credit accounts.
Concerns and Financial Advisers’ Perspectives
Skeptics argue that pay-later loans may be misused by certain individuals. Sebastian Siemiatkowski, the CEO of Klarna, acknowledged the potential for misuse but reassured that his company strives to identify such users and either deny them loans or impose stricter terms. Klarna reports global default rates of less than 1 percent, and over a third of its customers in the United States repay loans early. However, a report by the Consumer Finance Protection Bureau revealed that nearly 43 percent of pay-later users had overdrawn their bank accounts within the past year, compared to only 17 percent of non-users. Financial advisers working with low-income Americans have noticed an increase in pay-later loan usage among their clients, leading to a cycle of relying on cash advances to cover such loans when paychecks are insufficient.
The Need for Increased Reporting and Accountability
One major concern with pay-later loans is that many of them are not reported to credit agencies. This lack of reporting prevents companies like Klarna, Afterpay, and Affirm from being aware of individuals’ existing debts with other lenders. Credit bureaus such as TransUnion, Experian, and Equifax have expressed support for more comprehensive reporting of these loans and are implementing new systems to address this issue. The current credit-rating system tends to favor longer-term loans, which may negatively impact borrowers’ credit scores, even if they repay their pay-later loans in full and on time.
In conclusion, while pay-later loans have contributed to a robust holiday shopping season, concerns about their potential negative impact on consumers’ financial well-being and the stability of the financial system remain. Efforts are being made to increase reporting and accountability in the industry to mitigate these risks.
Pay-Later Loans and Vulnerability in Challenging Times
According to Marco di Maggio, a professor at Harvard Business School, more people tend to rely on pay-later loans for smaller expenses during difficult periods, which can lead to financial trouble.