Buy Now, Pay Later transactions (BNPL) are increasing dramatically. And for some folks, they are probably positive. But for others, BNPL can create significant problems.
In case you don’t already know, the typical BNPL transaction enables consumers to purchase something by making four equal payments, one on the date of the purchase and the other three in two-week intervals. BNPL transactions are interest-free and don’t charge a finance charge. BNPL transactions are structured this way precisely to avoid being subject to the Truth in Lending Act, an effort which backfired, at least for a while when Rohit Chopra’s CFPB issued an interpretive rule concluding that BNPL transactions should be treated the same way as credit cards for some purposes. But the Trump CFPB has withdrawn that interpretive rule, though courts could still be persuaded by its reasoning.
You might wonder why BNPL providers would make interest-free loans. The answer is that they pay the sellers less than the amounts the borrowers pay them, less than even credit card issuers. That might lead you to wonder why sellers would agree to BNPL transactions, as they are being paid less. The answer is that many BNPL borrowers buy a lot more using BNPL than they would if they were paying in other ways.
But what’s good for sellers can be bad for buyers. Some consumers overuse BNPL. And it turns out that a lot of BNPL borrowers start out in financial trouble.
Well, you might think BNPL lenders would engage in careful underwriting to make sure they’re not lending to borrowers in financial difficulties. But no; BNPL providers typically make only a soft pull of applicants’ credit reports. Instead, BNPL providers protect themselves by arranging to be automatically repaid out of their customers’ bank accounts or credit cards. So the BNP provider gets paid, but when the borrower’s credit card bill or some other bill comes due, the consumer lacks the money to pay it. One study found that BNPL users are five times as likely to default on their credit cards as on BNPL transactions. In other words, BNPL lenders can afford to make riskier loans than other lenders because they are less likely to suffer the consequences of that riskier lending; any losses are more likely to affect other lenders and ultimately, the borrowers.
Hence the perverse incentives: one is that borrowers are incentivized to buy more than they can afford. The other is that BNPL providers are incentivized to engage in less thorough underwriting because someone else suffers the consequences of their improvident lending.
Too bad we don’t really have a functioning CFPB at the moment. States should step in to protect their citizens, and some have, but plenty of others won’t.
Something else I wonder about: given that retailers don’t collect the full purchase price from the BNPL provider, is this a situation in which the finance charge is hidden? if so, it would be subject to TILA, which is triggered by charging a finance charge.
