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Lowry: Treat buy now, pay later loans like real debt

By Erin Lowry, Bloomberg Opinion
Published: May 19, 2024, 5:24am

It’s been close to two years since the Consumer Financial Protection Bureau indicated it was looking to tighten regulations on popular “buy now, pay later” services. Since then, the sector has grown to $300 billion. It’s time to bring meaningful transparency to an industry that has drawn in legions of consumers, including those considered too young to be handed credit cards.

A logical and long overdue step would be to have the transactions included in consumers’ credit reports, treating pay-later loans offered by Klarna Bank AB, Affirm Holdings Inc. and other providers more like those available from credit cards.

Integrating pay-later loans into credit reports would allow lenders to flag shoppers with troubled credit histories and potentially keep those consumers from falling deeper into debt. But many pay-later providers are reluctant to provide data to credit bureaus. They argue that credit reports weren’t designed to incorporate short-term pay-later loans.

There is some validity to that claim. Some shoppers take out multiple loans in a short period of time when buying everything from shoes to concert tickets. While that could appear to lenders like a desperate grab for credit, akin to opening a bunch of credit cards in rapid succession, the majority of borrowers pay off the loans on time, generally in six weeks.

Yet this feels like a bit of a red herring. For one, credit bureaus can adjust to reflect the risks of different types of loans and debt.(1) For example, credit bureaus recently started to remove medical debt from credit reports to avoid dinging credit scores and punishing consumers for seeking medical care. Consumers also would likely adjust their behavior if they saw that multiple, overlapping pay-later loans were driving down their credit scores.

For now, the lack of reporting means traditional lenders are being left in the dark about their potential customers’ finances, which could easily lead to consumers, especially younger ones, borrowing more money than they should.

Pay-later services emerged more than a decade ago, but really found a market during the pandemic when online shopping skyrocketed. Typically, the services allow shoppers to pay off a purchase in four interest-free installments over a short time period, usually six to eight weeks, giving rise to the term “pay-in-four.” Unlike credit cards, which have been largely restricted to consumers 21 and older since new rules were adopted 15 years ago, pay-later loans are generally available to shoppers as young as 18.

The lower age minimum is significant at that stage of life, when consumers are just beginning to learn about proper credit management and other financial concerns. With fewer safeguards, pay-later plans raise the risk that consumers will rack up too much debt too quickly. And it’s especially worrisome that financially fragile households are disproportionately more likely to use pay-later services, according to recent data from the New York Federal Reserve.

Most pay-in-four plans are advertised as being interest-free, something that should always raise a red flag. The companies need to make money somehow, and in addition to fees from retailers, many pay-later providers, including Affirm and Klarna, also offer longer-term installment loans that can charge credit card-level, or higher, rates. It isn’t a huge leap to imagine customers taking out short-term, no-interest loans and then moving up to interest-bearing loans from the same provider for larger purchases. Indeed, nearly three-quarters of Affirm’s products are interest-bearing, according to the company’s first-quarter earnings report. Klarna offers loans ranging from 6 to 24 months with annual percentage rates of between 7.99% and 33.99%.

It isn’t surprising that pay-later lenders are wary of reporting to credit bureaus. It could reduce their customer base. Once shoppers start seeing their pay-later loans affecting their credit score they might be less likely to use the services, or just get worried about their risk of rejection.

Some states have taken it upon themselves to attempt to protect consumers and check pay-later companies. In early 2024, New York Governor Kathy Hochul proposed that pay-later companies obtain a license to operate in New York State. New York would then be able to limit late fees, require companies to report to credit bureaus and introduce additional layers of fraud protection that mirror those in the credit card industry. California has already taken such steps and requires pay-later companies to be licensed to operate in the state.

But at least one pay-later lender didn’t need a regulatory mandate to do the right thing. Apple Inc. announced in February that it would start self-reporting lending data from its Apple Pay Later service to Experian.

Given the continued inflation pinch and the pervasive feeling that goods and services remain expensive, it’s easy to see how pay-later delinquencies could become a bigger problem. That is, unless regulators start putting reasonable guardrails around these burgeoning services. Requiring the companies to report into credit bureaus — and asking credit bureaus and credit-scoring agencies to figure out how to absorb and process that data — hardly seems like too much to ask.

Erin Lowry is a Bloomberg Opinion columnist covering personal finance. She is the author of the three-part “Broke Millennial” series.