How ‘Buy Now, Pay Later’ Makes Billions From ‘Free’ Loans | WSJ The Economics Of

Key Concepts:

• Buy Now, Pay Later (BNPL): An alternative to credit cards that allows consumers to make purchases and pay them off in installments, often with zero interest for pay-in-four plans.
• Pay-in-Four: The most common BNPL structure, where the purchase amount is divided into four equal payments, typically due every two weeks.
• Merchant Fees: Fees charged to retailers by BNPL providers for offering the service to their customers.
• Underwriting Model: The process used by BNPL providers to assess the creditworthiness of potential borrowers.
• Consumer Credit Losses: Losses incurred by BNPL providers due to customers failing to repay their loans.
• Credit Reporting: The process of sharing consumer data, including BNPL loan information, with credit bureaus.
• Revolving Credit: A type of credit that allows borrowers to repeatedly borrow and repay funds, such as credit cards.

1. Overview of the Buy Now, Pay Later (BNPL) Industry

• The BNPL industry has experienced rapid growth as an alternative to traditional credit cards.
• The narrator quotes someone saying "We really believe the credit card industry is going the way of the VHS tape."
• Three major players dominate the U.S. BNPL market: Afterpay, Klarna, and Affirm.
• Afterpay was founded in Australia in 2014 by Nick Molnar to boost sales at his jewelry store.
• All top providers offer the "pay-in-four" installment loan structure with zero interest.

2. How BNPL Works

• When a customer chooses BNPL at checkout, the provider approves the loan based on its underwriting model.
• The provider pays the retailer the next day and assumes the risk of non-payment.
• Customers follow a four-part repayment plan with no interest (for pay-in-four). Late payment fees may apply.
• BNPL providers charge merchants a fee, sometimes up to 5% of the transaction value.
• The narrator quotes someone saying "The lion's share of our income, 90-plus percent of our income, is made from the merchant, not the consumer."
• Some lenders, like Affirm, offer longer-term loans with interest. Affirm states that "About 20% of our business today is 0%, and about 80% has interest on them."
• Afterpay also has a pay-monthly option for larger purchases with simple interest.

3. Expansion and Competition

• BNPL transaction volume has increased 20-fold since 2019.
• The narrator quotes someone saying "You have the clear macro trend around consumers choosing alternative ways to pay."
• Klarna has an exclusive deal with Walmart through the retailer's fintech arm, OnePay.
• The narrator quotes someone saying "It's extremely important for the BNPL providers, particularly the specialist BNPL providers, to have those direct relationships with the merchants."
• BNPL is expanding beyond e-commerce retail to smaller ticket sizes and consumable purchases.
• A LendingTree survey found that 25% of BNPL customers have used it for groceries, up from 14% in 2024.

4. Concerns and Risks

• A CFPB study found that over two-thirds of BNPL loans went to borrowers with lower credit scores.
• The narrator quotes someone saying "Buy now, pay later can make products look a lot more affordable than they actually are."
• Klarna reported a 17% increase in consumer credit losses year-over-year in May, but stated this was due to issuing more loans.
• LendingTree found that 41% of BNPL users paid late in the past year, up from 34% the year before.
• Affirm has reported a decrease in customer defaults.
• Afterpay disables accounts after one late payment and issues smaller order values compared to credit cards.

5. Regulatory Landscape and Credit Reporting

• In 2024, the CFPB issued an interpretive rule subjecting BNPL providers to credit card regulations, but enforcement is not being prioritized.
• FICO announced it would add BNPL loans to credit reports.
• Affirm shares consumer data with credit bureaus and TransUnion.
• Klarna and Afterpay are withholding customer data until they are assured customers won't be unfairly penalized.
• Block (Afterpay's owner) argues for a separate framework for BNPL and credit cards.

6. Future of BNPL

• The narrator quotes someone saying "I don't think that BNPL will replace credit cards. I think it's gonna replace credit cards for certain people and may replace credit cards for many people for certain types of transactions."
• The narrator quotes someone saying "Nothing would make our team happier than if we could see the death of revolving credit in the United States."

Synthesis/Conclusion:

The BNPL industry has grown rapidly by offering an alternative to credit cards, particularly through its "pay-in-four" installment plans. While BNPL provides convenience and accessibility, concerns exist regarding consumer debt, credit losses, and regulatory oversight. The industry is evolving, with providers expanding into new markets, offering longer-term loans, and grappling with how to integrate with credit reporting agencies. The future of BNPL likely involves a hybrid approach, where it coexists with credit cards and caters to specific consumer needs and transaction types.