How does buy now, pay later work?

Get in losers, we're going shopping.

Mashable SEA Aug. 3, 2022

I don't suffer from chrometophobia — the fear of spending money — nor do I have a compulsive buying disorder, which actually affects about 18 million adults in the U.S. But despite a desire to be an earth tone/thrift store/reusable soap kind of person, I just really want stuff.

I want the baggu hat that you can fold up and put in your bag. I want the Frankie Shop cargo trousers from Net-a-Porter. I want a tofu press and Dolce Vita Wiley heels and the Tekla X Stüssy cotton poplin shirt and honestly, I want the platform crocs. But I don't buy any of them because I don't have the money to buy any of them. Enter: Buy Now, Pay Later.

Using context clues, I bet you can decipher what Buy Now, Pay Later, or BNPL, means: You can have those platform crocs by only paying a fraction of the cost today, as long as you finish paying the full price over the next few weeks. With a world primed to lean into our every material desire but an economy that doesn't quite match, BNPL has been a hit.

And BNPL is just the latest variation on a retail theme. In the 1970s, layaway, in which consumers paid fees to reserve goods they couldn't yet afford, was so popular it was the name of an Isley Brothers song. And still popular today are rent-to-own stores like Aaron's, which let consumers take things home from a big box store for a fraction of the actual cost, and then incrementally pay them off, for a price. The common thread: these are all credit-free ways to make owning items more attainable that, if we're honest, also make the items themselves cost more. Sometimes a lot more.

BNPL in particular makes money with transaction fees. So, if I were to use BNPL to buy that baggu hat off of Urban Outfitters, Urban Outfitters would have to pay about three to six percent of that purchase price to the BNPL firm. If you don't meet the deadlines to finish your payment, you have to pay a late fee, which is another source of revenue for BNPLs.

People — particularly young people and low-income people — are buying things with aplomb, assured that they'll be able to pay for all of it with small chunks of cash every week or so. BNPL allows shoppers to pay less now without having to worry about interest rates, like you might on a credit card. It's an attractive option at checkout — but it has the potential to impact young people and low income people more than anyone else.

Benedict Guttman-Kenney, an economics PhD candidate at the University of Chicago Booth School of Business, has studied some BNPL trends in the U.K. He found that "mainly younger people" and low-income people use BNPL, and they tend to put it on their credit card — which can compound the added cost.

"It seems to be like the people who you are potentially most worried about are using these products and putting them on their credit cards," Guttman-Kenney told Mashable.

Beyond his own research, there's data in the U.S. that backs this up. Many, although not all, people use BNPL not as a way to spread out heavy financial costs, but because they have to. According to the Federal Reserve Bank, just over half of people who used BNPL also said it was "the only way they could afford their purchase."

But they also use it because it's easy. According to a Philadelphia Fed survey, 52.6 percent of people who use BNPL do so out of convenience. The size of the purchase and the ability to better manage finances were also top reasons folks used BNPL at 46.2 percent and 43.8 percent respectively. The least chosen options were "it is my preferred payment method" at 11.5 percent, "inability to get approved for credit" at 13.6 percent, and lack of credit at 19.1 percent. "This particular observation is interesting, given BNPL’s reputation as a last-resort credit product for those who do not have access to traditional credit," the report reads, adding that other data does show there is variation across demographics. For instance, people who earn less than US$40,000 were more likely to cite "inability to get approved for credit" than people who earn US$75,000 or more.

The Federal Reserve Bank also reported that people with lower income and less education tend to use BNPL more.

"Around 13 percent of those with income below US$50,000 used BNPL in the prior year, compared with 7 percent of those with an income of US$100,000 or more," the report read. "Similarly, 14 percent of people with less than a high school degree used BNPL, compared with 8 percent of those with at least a bachelor’s degree."

Because of that, some people say BNPL can be a bit predatory. A Credit Karma survey shows that 22 percent of BNPL consumers in the U.S. repay using their credit card — which is consistent with research out of the U.K. conducted by Guttman-Kenney and his peers.

"I don't see it as a predatory product. It's not like a payday loan where it has very high interest rates and it's very easy for someone to get into a problem with," Guttman-Kenney said. "The thing with BNPL is how good or bad it is depends on how the consumer uses it."

Hyepin Im, the president and CEO of Faith and Community Empowerment, a nonprofit that helps connect communities of color and underserved communities with resources and opportunities, says that this kind of a tool has the potential to lead people into buying things they simply can't afford — and might be difficult to dig themselves out of.

"It's predatory in the sense that a lot of people get pulled in, but there's hefty fines if you miss a payment," Im told Mashable. "And unfortunately, a lot of people are pulled into this situation by using this tool to buy things from multiple vendors who have their own payment schedule."

But Im sees how something like this could also be attractive — or helpful — to low-income communities. She said that the no interest payments seem nice, and can help people to buy the things they need when they need them. That's where it can get sticky, though.

"For many people who are low income, the safety net reserves are really very low," Im said. "You have one car accident, you have a health problem, whatever, and you don't get to go to your work. Then that ability to pay that partial payment becomes very unrealistic. And so it's not just that you forget the payment, but you also then face life circumstances for which you don't have reserves. And so that increases the likelihood of missing that payment."

Im said one way to make BNPL "less predatory" is to increase regulations around it. And Guttman-Kenney agrees. He compared BNPL to a single transaction on a credit card, which is precisely how the government might want to look at it while considering regulations.

"One [regulation could be] having some form of disclosure standardizing what is required. That is probably useful, and I'd be very surprised if that didn't happen," Guttman-Kenney said. "And the way disclosure is done at the moment isn't great. It's here's this long table, or these many pages that no one reads. So I think as a more general point, there are some disclosures that could be done better."

Guttman-Kenney is referring to things like making the terms and conditions more clear. Im made a similar point, but added that no matter what, all of us should be circumspect "of any new players without regulations." With the term "players," in this context meaning "ways of doing business."

"History demonstrates that [in cases of] businesses without regulation, their priority is making money at the cost of consumers and customers," Im said. "We should all be wary and to advocate and fight for greater oversight and regulation before too many people get hurt along the way."