Americans May Be Taking on Too Much 'Phantom Debt' to Pay Later

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“Buy now, pay later” loans are helping fuel an unprecedented holiday shopping season. Economists worry they may also be masking and exacerbating cracks in Americans' financial well-being.

Loans, which allow consumers to pay for purchases in installments, often interest-free, have gained popularity due to high prices and interest rates. Retailers have used them to attract customers and get people to spend more.

But those loans may be encouraging younger, lower-income Americans to take on too much debt, according to consumer groups and some lawmakers. And because these loans are not routinely reported to credit agencies or recorded in public data, they could also represent a hidden source of risk for the financial system.

“The more I look into it, the more concerned I am,” said Tim Quinlan, a Wells Fargo economist who recently published a report describing pay-later loans as “phantom debt.”

Traditional measures of consumer credit indicate that the finances of American households overall are relatively healthy. But, Quinlan said, “if they're missing the fastest-growing part of the market, then those guarantees aren't worth it.”

Estimates of the size of this market vary widely. Quinlan believes spending through pay-later options was about $46 billion this year. That's small compared to the more than $3 trillion Americans put on their credit cards last year.

But those loans, offered by companies such as Klarna, Affirm, Afterpay and PayPal, have increased rapidly at a time when some Americans' finances are showing early signs of strain.

Credit card debt is at a record level in dollar terms – though not as a proportion of income – and delinquencies, while low by historical standards, are rising. That stress is especially evident among younger adults.

People in their 20s and 30s are by far the largest users of post-payment loans, according to the Federal Reserve Bank of New York. That could be both a sign of financial problems (young people may be using pay-back loans after maxing out their credit cards) or a cause of them by encouraging them to spend excessively.

Liz Cisneros, a 23-year-old college student from Chicago who works part-time at Home Depot, said she was surprised by the ease of the pay-later programs. During the pandemic, she saw influencers on TikTok promoting the loans and a friend of hers said they helped her buy designer shoes.

Cisneros began using them to buy clothes, shoes and beauty products from Sephora. He often had several loans at once. He realized that he was spending too much when he didn't have enough money while he was in line at the supermarket checkout. A later payment company had withdrawn funds from her bank account that morning and she had lost track of her payment schedule.

“It's easy when you keep clicking and clicking and clicking, and then you don't,” he said, referring to when you realize you've spent too much.

Cisneros said the problem was particularly intense at Christmas and that he was not shopping for the holiday this year to pay off his debts.

Pay later loans were available in the United States years ago, but they took off during the pandemic as online shopping increased.

The products are somewhat similar to layaway programs offered decades before by retailers. Online shoppers can choose between pay later options at checkout or in pay later company apps. Loans are also available in some physical stores; Affirm said Tuesday that it had begun offering pay-later loans at self-checkout counters at Walmart stores.

The most common loans require buyers to pay a quarter of the purchase price up front and the remainder is usually paid in three installments over six weeks. These loans are usually interest-free, although sometimes users end up owing fees. Pay-later companies make most of their money by charging fees to retailers.

Some lenders also offer interest-bearing loans with repayment terms that can last from a few months to more than a year.

Pay later companies say their products are better for borrowers than credit cards or payday loans. They say that by offering shorter loans, they can better assess borrowers' ability to pay.

“We can identify and extend credit to consumers who have the ability and willingness to pay more than revolving credit accounts,” Michael Linford, Affirm's chief financial officer, said in an interview.

In its most recent quarter, 2.4 percent of Affirm's loans were delinquent by 30 days or more, up from 2.7 percent a year earlier. Those figures exclude his four-payment loans.

The service makes more sense for certain purchases, such as buying an expensive sweater that will last for many years, said Klarna CEO Sebastian Siemiatkowski.

He said paying later probably made less sense for more frequent purchases like groceries, although Klarna and other companies offer their loans at some grocery stores.

Siemiatkowski acknowledged that people could misuse his company's loans.

“It's obviously still credit, so you're going to find a subset of people who unfortunately don't use it as intended,” said Siemiatkowski, who founded Klarna in 2005. He said the company tried to identify those users. and deny them loans or impose stricter conditions.

Stockholm-based Klarna says its global default rates are less than 1 percent. In the United States, more than a third of customers repay their loans early.

Kelsey Greco made her first pay-later purchase about four years ago to buy a mattress. Paying $1,200 in cash would have been difficult, and making the purchase with a credit card didn't seem wise. She then obtained a 12-month interest-free loan from Affirm.

Since then, Greco, 30, has used Affirm regularly, including for a Dyson hair tool and car brakes. Some of the loans charged interest, but he said that even then he preferred this form of loan because he was clear about how much he would pay and when.

“With a credit card, you can swipe it all day and say, 'Wait, what did I just get myself into?'” said Ms. Greco, a Denver resident. “Whereas with Affirm, it gives you these clear numbers where you can see, 'OK, this makes sense' or 'This doesn't make sense.'”

Greco, who was introduced to The New York Times through Affirm, said pay-later loans helped her avoid credit card debt, which she previously struggled with.

But not all consumers use pay later options carefully. TO report from the Consumer Finance Protection Bureau This year it found that almost 43 percent of pay later users had overdrawn a bank account in the previous 12 months, compared to 17 percent of non-users.

“This is simply a more vulnerable portion of the population,” said Ed deHaan, a researcher at Stanford University.

in a published article Last year, DeHaan and three other academics found that a month after first using post-payment loans, people were more likely to experience overdrafts and start racking up late fees on their credit cards.

Financial advisors who work with low-income Americans say more clients are using pay-later loans.

Barbara L. Martinez, a financial advisor in Chicago who works at Heartland Alliance, a nonprofit group, said many of her clients used cash advances to cover pay-it-forward loans. When paychecks arrive, they don't have enough to cover the bills, forcing them to resort to more pay-it-forward loans.

“It's not that the product is bad,” he added, but “it can get out of control very quickly and cause a lot of damage that could be avoided.”

Briana Gordley learned about pay later products in college. She worked part-time and couldn't get her approved for a credit card, but pay later providers were eager to extend her credit. She began to fall behind when her work hours were reduced. Finally, family and friends helped her pay off her debts.

Mrs. Gordley, who testified about his experience last year at a listening session hosted by the Senate, now works on consumer finance issues for Texas Appleseed, a progressive policy organization. She said repayment loans could be an important source of credit for communities that lacked access to traditional loans. He still uses them occasionally for major purchases.

But he said companies and regulators needed to make sure borrowers could afford the debt they were taking on. “If we're going to create these products and develop these systems for people, we also have to implement some checks and balances.”

The Truth in Lending Act of 1968 requires credit card companies and other lenders to disclose interest rates and fees and provides borrowers with various protections, including the ability to dispute charges. But the law applies only to loans with more than four payment installments, effectively excluding many post-payment loans.

Many of these loans are also not reported to the credit bureaus. As a result, consumers could have multiple loans with Klarna, Afterpay and Affirm without the companies knowing about the other debts.

“It's a huge blind spot right now, and we all know it,” said Liz Pagel, a TransUnion senior vice president who oversees the company's consumer lending business.

TransUnion and other major credit bureaus and pay later companies say they support increased reporting.

But there are practical obstacles. The credit scoring system better rates borrowers for having longer-term loans, including long-standing credit card accounts. Each pay later purchase qualifies as a separate loan. As a result, those loans could lower borrowers' scores even if they repay them on time.

Pagel said TransUnion had created a new reporting system for loans. Other credit bureaus, such as Experian and Equifax, are doing the same.

Pay later companies say they are reporting certain loans, particularly those with longer terms. But most do not report and do not commit to reporting loans with only four payments.

That worries economists, who say they are particularly concerned about how those loans will play out when the economy weakens and workers start losing their jobs.

Marco di Maggio, a Harvard Business School professor who has studied pay-later products, said that when times were tough, more people used such loans for minor expenses and got into trouble. “It only takes one more shock to push people into default.”



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