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Buy now, pay later financing has taken off in recent years and regulators are taking note. Although lenders offering this financing tout its convenience, consumer advocates are concerned about inadequate regulation. The ease with which consumers can access this lending could also lead them to bite off more than they can chew.
Last December, the Consumer Financial Protection Bureau (CFPB) launched an inquiry into some financial technology firms offering BNPL financing. The agency sought input from Affirm, Afterpay, Klarna, PayPal and Zip on the risks and benefits of their BNPL offerings.
According to Rohit Chopra, CFPB director, “Buy now, pay later is the new version of the old layaway plan, but with modern, faster twists where the consumer gets the product immediately but gets the debt immediately, too.”
As the name implies, this sort of financing enables consumers to buy and take possession of an item, and then pay for it in a specific number of payments, usually four or less, or over a specified time period. Consumers also typically make a down payment on the purchase. Merchants accepting this form of financing pay a charge, varying from 3 percent to 6 percent of the purchase price, to BNPL lenders because it helps them generate more sales.
This niche has certainly seen fast growth in the last few years. According to a report from Accenture (commissioned by Afterpay), the number of BNPL users in the U.S. has increased by more than 300 percent every year since 2018. By 2021, there were 45 million active users spending more than $20 billion.
Consumer protection issues
Despite such growth, there are certain shortfalls in terms of the protections offered by BNPL financing. The CFPB, for instance, points to issues of “regulatory arbitrage” and use of consumer data to generate more sales.
It seems lenders may not be making adequate consumer disclosures, and protections that apply to credit card purchases don’t hold good for BNPL financing. For instance, it may not be easy to hold a merchant accountable in case there is an issue.
Also, it’s easy to accumulate debt through this form of financing since BNPL lenders, unlike credit card lenders, don’t need to consider consumers’ ability to repay a loan before lending to them. Consumers are charged a late fee when they don’t make payments on time, though the lenders say that there is no other financing fee associated with BNPL financing.
Responding to a notice put out by the CFPB asking for public comment, consumer Erica Paige noted that her usual practice for large purchases is to charge her credit card and then pay off the balance with her next paycheck.
“I thought it seemed nice to separate the payments out without interest, making it feel like less of a blow,” Paige said. “But I did spend more money than usual because it was so easy. I ended up just paying off the amounts after a couple weeks because I really don’t like lingering debt.”
She observed that the process of getting the loan was easy, without involving any credit check, and the only information required was her credit card number (so that she was essentially using her credit card to pay off another loan).
Commenting on concerns relating to data privacy, the public interest research organization Electronic Privacy Information Center, stated, “EPIC urges the Bureau to supplement its proposed inquiry to better capture the data collection, usage, disclosure, and retention practices of BNPL providers. This will improve transparency and oversight of an industry that seems to be gaining traction among multiple marginalized consumer populations.”
A group of 77 consumer organizations, including the Center for Responsible Lending and Consumer Reports, recommends that credit card rules be applied to BNPL credit that give consumers protections such as “dispute and chargeback rights, cost transparency, uniform disclosures and statements, reasonable penalty fees, and underwriting for a consumer’s ability to repay.”
Making BNPL lenders more accountable
Although BNPL lenders could be subject to a variety of federal laws, they are not being held accountable because of the way they operate.
“The ‘pay in four’ business model appears designed to evade the Truth in Lending Act, which, among other TILA requirements, requires 5 payments to trigger its installment lending rules,” said Ed Mierzwinski, senior consumer director for U.S.P.I.R.G., a consumer advocacy group. “TILA’s Fair Credit Billing Act, which applies to open-end credit, requires open-end creditors (including credit and charge cards) to give you certain billing and dispute rights. Yet, the BNPL firms appear to slough off those creditor requirements onto merchants.”
Mierzwinski added that BNPL firms could also be subject to the Electronic Fund Transfer Act, which says consumers can’t be required to use a certain payment method, such as automatic withdrawals. There have been complaints that not all BNPL lenders have been following this requirement. Mierzwinski expects the CFPB to make clear that BNPL financing is subject to TILA and to EFTA so these laws are enforced in this niche.
“We are supportive of partnering with policymakers to increase understanding of how consumers use BNPL solutions and the impact on their financial well-being,” said Penny Lee, chief executive officer of the Financial Technology Association, a trade group for the fintech niche, in response to the CFPB’s request for input. “Future policy should be predicated on proper analysis of real-world outcomes for consumers, including with respect to credit reporting, financial health, and consumer choice and preferences.”
State-level regulatory efforts
States such as California and Oregon have been more proactive than others in holding BNPL companies accountable. In Oregon, these companies are subject to the laws governing retail instalment contracts. Jason Horton, a spokesman for Oregon’s Department of Consumer and Business Services noted that other states are also looking into how best to monitor this space.
“Regulatory trade organizations, such as National Association of Consumer Credit Administrators (NACCA), frequently provide model laws or guidance to states to help create more uniform regulation,” Horton said. “It’s possible the committee (NACCA emerging issues committee) will recommend NACCA produce a white paper or model law in this area, but the committee only recently started looking into this.”
In California, BNPL financing is subject to the California Financing Law and also requires licensing under this regulation. In 2020, the state ordered QuadPay, Afterpay, Sezzle and Klarna to refund fees received from borrowers and get licensed under the CFL.
“Today, companies offering ‘Buy Now, Pay Later’ products in California are required to take into consideration a borrower’s ability to repay the loan and are subject to strict rate and fee caps,” said Mark Leyes, a spokesman for the state’s Department of Financial Protection and Innovation. “Like other CFL licensees, these companies must address consumer complaints submitted to the Department, giving consumers additional recourse and protections when they suspect they’ve been wronged.”
Credit reporting concerns
In joint input responding to the CFPB’s request for public input, the attorneys general of 21 states noted that, in addition to the concerns voiced by other authorities, they’re concerned about the fallout of BNPL loans on consumers’ credit reports.
Credit reporting bureaus, which did not previously report on BNPL loans, recently announced plans to add these loans to credit reports. “The introduction of credit reporting to the BNPL industry may come with a host of other problems,” noted the attorneys general. “In fact, one-third of complaints about BNPL loans submitted to the CFPB so far concern incorrect information on a consumer’s credit report. We urge the CFPB to analyze BNPL policies and procedures for credit reporting and the information that BNPL providers furnish to credit bureaus.”
They also voiced concerns about debt collector follow-up in case these loans go into collections. It seems debt collectors don’t have enough input to validate the loans and identify consumers correctly since BNPL lenders don’t get a lot of consumer input, or rely on credit reports, to make these loans.
BNPL lenders that report to credit bureaus would be subject to Fair Credit Reporting Act regulations.
Credit card lenders also offering BNPL plans
According to the CFPB, it’s not clear the extent to which BNPL loans compete directly with credit cards. While it’s likely BNPL loans are taking some market share from credit cards as a means of consumer financing, it’s also possible BNPL availability in itself has sparked some consumer demand.
Some card issuers have started offering installment payment plans for credit cards. Card payment networks Visa and Mastercard have also added capabilities to allow card issuers to offer installment payments.
In commentary submitted to the CFPB, Visa noted, “The CFPB should tailor its approaches to preserve consumers’ and merchants’ ability to access a wide variety of installment options and maintain competition among BNPL solutions, so that consumers have maximum flexibility to access the installment options of their choice.”
This growing proliferation of BNPL lenders has also raised concerns that they might have to cut down on the fees they charge merchants. This could lead them to make up for the lost income by adding on other charges to consumers.
“BNPL is challenging the existing credit card business models,” said Mierzwinski. “Card companies are fighting back. The exploding use of BNPL and its changing business models require constant re-assessment and evaluation of its impact on markets and consumers.”
The bottom line
Installment payments using BNPL financing have grown rapidly and attracted the attention of regulators. The CFPB is looking into how best to regulate this space, considering protections available to credit cardholders are mostly not available for users of BNPL financing. Card networks are also tapping into this space, enabling card issuers themselves to offer installment payments.