Buy Now, Pay Later: The next financial crisis?

You may have noticed more “buy now, pay later” options online and in-store checkouts, for anything from clothes to electronics to furniture. Target is one of the latest retailers to announce it is offering this payment option ahead of the holiday shopping season. WINK News Investigative Reporter Celine McArthur explains how it works and what you need to know before you sign up.

Supply chain disruptions could make your holiday shopping extremely challenging, so some retailers are encouraging you to buy now, if what you want is currently in stock. But what if you don’t have the cash NOW? “Buy now, pay later” installment plans are now offered by big-name retailers including Target in their stores and on their websites. We take a closer look at the pros and cons of that choice at the checkout, so you know what you’re getting into if you sign up.

We first introduced you to Andrew Williams and his dog Stella in September. He bought Stella at a local pet store thanks to its on-the-spot, in-store financing.

“I figured that was something that I could do if I picked up an extra day or two a week for works,” says Williams.

Williams isn’t alone. A Credit Karma survey says 44% of Americans have used “buy now, pay later” services. They’re instant approval, point-of-sale loans through third-party companies. The big ones include Affirm, Klarna, Afterpay and Sezzle. The loans are usually short term—and unlike most credit cards—interest free IF you make your payments on time and in full. Nerdwallet’s personal finance expert Kimberly Palmer says they’re also easier to qualify for.

“That’s because your credit often isn’t checked at all,” says Palmer. “The target audience is young people, young people who don’t have a big credit history, they might not have access to credit cards. And this just seems like an easy solution, an easy way to buy things that you want, but you can’t afford right now.”

Some B-N-P-L companies are strong on social, showcasing luxury goods you can finance through their payment platforms. Palmer’s advice as you scroll through their posts—beware of the temptation to splurge.

“It is still a form of debt you still have to eventually make those payments, and in some cases, you’ll be paying even more because there are fees and interest rates baked in,” says Palmer.

Williams says he made the Dalmatian deal through third-party provider American First Finance without fully understanding what the company says was spelled out in the contract.

“The interest on it after a certain amount of time, it just completely just skyrockets,” says Williams.

Williams ultimately paid two and a half times Stella’s sticker price. Palmer hasn’t seen his contract and never heard of American First Finance, but says you can learn from Williams’ experience.

“The problem is that it is a relatively new product to a lot of people,” says Palmer. “So, it’s not something that’s widely understood, we don’t know where to look to see what is the interest rate, what are the fees.”

“It’s just a recipe… It’s a recipe for disaster,” says Florida Gulf Coast University Economics Professor Thomas Smythe, Ph.D. “I fundamentally believe our next financial crisis is going to be driven by a lack of understanding of financial products, poor financial literacy.”

Professor Smythe explains how the financial technology, or fintech-driven “buy now, pay later” industry could contribute to that crisis.

“We as individuals, are being asked—required—to do much more in our personal financial lives than we have ever before. And there are more and more extremely complex products, ideas, programs that are out there that people just don’t understand,” says Smythe.

When it comes to “buy now, pay later,” Professor Smythe fears too many uninformed consumers aren’t the only ones at risk.

“I’m not sure the retailers understand it either. Especially small businesses, ” says Smythe.

Melea Pruskauer—owner of Lil Rascals Puppies, where Williams bought Stella—couldn’t tell us much about American First Finance or how it operates.

“They’re just a third party to us, so we don’t know a whole lot of detail about them,” says Pruskauer.

Williams says his experience buying Stella will change where and how he shops in the future.

“Because at the end of the day, they’re just trying to make the sale, and they’re trying to get as much money as they possibly could,” says Williams. “I would just stay away from it in the first place.”

The Florida Attorney General’s office received five complaints this year about American First Finance regarding high interest rates and other issues. In response, American First Finance said they always respond to complaints and “resolve them accordingly.”

We reached out to the big BNPL providers Klarna, Afterpay, Affirm and Sezzle, and asked a series of questions so you can compare services for yourself. You can see them below.

If you have something you want me to investigate, email me at celine.mcarthur@winknews.com.

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Question: Can you clarify what the interest rates are and the cost of late fees for your service? Our viewers are asking me for numbers and details.

Affirm’s response

Affirm is a transparent, flexible alternative to credit cards and other pay-over-time options. We provide consumers control, flexibility, convenience, and increased purchasing power. Affirm never charges any late or hidden fees. Affirm offers 0% APR and simple-interest bearing transactions ranging from 0-30% APR. Affirm’s 0% APR offers have no fees or deferred, hidden, or surprise interest, ever. For the interest-bearing transactions we facilitate, we charge simple interest that never compounds and quote everything in dollar terms so it’s easy to understand and budget. Customers never pay a penny more than what they agree to up front because any interest charged is a fixed percentage based on the principal amount of the loan. 0% APR financing represented 43% of Affirm’s total gross merchandise volume for our fiscal year ending June 30, 2021.We underwrite each transaction individually and payment options (both length of term and interest rate) are determined by a combination of the merchant, the purchase amount, the pay-over-time program the consumer chooses and our underwriting process.

Some merchants offer 0% APR specific promotions or decide to give all qualified customers 0% APR always.

Sezzle’s response

There is no interest, ever, with Sezzle’s pay-in-4 option. Sezzle never charges late fees, we only charge fees for two reasons: either a payment has failed or more than one reschedule has been applied to an order (the first reschedule is free). The account reactivation fee to open up an account after it is closed due to failed payment is $10 or may differ, and possibly not apply, based on the state regulations of the user. Reschedule fees are $5 but again may differ based on the state regulations if applicable. We do have 1 free reschedule per order, and only subsequent rescheduled on the same order will have a fee

Afterpay’s response

Afterpay never charges interest or upfront fees and is completely free to the consumer if the payment is made on time. If a single payment is missed, the consumer can not use our platform – which ensures that he/she can’t fall into the revolving cycle of debt. In the US, our late fees are never more than $8 per payment and we always cap late fees on an individual order at 25% of the order amount. These rules help ensure we are always protecting our customers and that they are only buying items they can afford. To be clear, even if the consumer is late on their repayment schedule, customers are never charged interest. Afterpay also offers a hardship policy which allows for a flexible payment arrangement without charging any additional fees

Klarna’s response

As a bit of background, Klarna offers three products in the United States.: Pay in 4 (Klarna’s most popular payment method), Pay Later in 30 days, and Financing. For Pay in 4 and Pay Later in 30 days products we don’t charge consumers fees or interest. Ever. Our Financing product, designed for bigger ticket items, may be offered interest-free or interest-bearing depending on the merchant. Klarna has several checks in place so customers don’t miss their payments. At checkout, a payment schedule is clearly laid out so customers know when they will be charged with automatic payments made via their debit or credit cards until the full balance is paid. Additionally, Klarna sends additional emails and in-app reminders so customers are on top of their balance and payment schedule. In instances where we are unable to collect a scheduled payment, we immediately contact the customer to let them know there was an error in processing payment and asking them to try again. If that effort fails, only then will we issue a late fee (up to $7.00 and capped at a maximum of 25% of the past due installment, subject to applicable law.) We then add that missed payment into the next scheduled one and the customer is unable to use Klarna again until the balance is paid. Moving forward, we also limit that customer’s use of our payment programs.

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Question: Can you explain the type and extent of the background check you do before approving a customer?

Affirm’s response

The application process is the same for each consumer regardless of the merchant and there is no cost to apply to use Affirm. Checking if you prequalify by providing a few simple pieces of information (like name, phone number, email address, date of birth) never affects your credit score. There is no hard credit check when a consumer applies to use Affirm. Affirm leverages proprietary technology to underwrite each transaction individually, as opposed to extending a single line of credit. This unique approach allows Affirm to ensure we’re lending to consumers responsibly, while giving payment flexibility to as many people as possible. Unlike legacy payment and credit systems, we assess risk at a transaction level that allows us to consider the product that the consumer is purchasing. Affirm considers data beyond traditional credit scores, including transaction history and credit usage to predict repayment ability. We access and leverage item-level data, repayment data, consumer behavior data, and repeat-purchase data. The quality and quantity of our data allows us to more finely price transactions, measure risk, deliver value to our consumers, and personalize their experience.

Sezzle’s response

At Sezzle we do soft credit checks with every customer, and only give them a limit that our risk model determines they can safely payback. Over time, your credit limit increases as we see your positive repayment behavior.

Afterpay’s response

We do not complete any sort of background or credit check, because we are not a credit company. We have proprietary risk models that allow us to offer our service without using the traditional credit bureaus.

Klarna’s response

We conduct robust eligibility assessments on each and every transaction, which includes a soft credit check, so we take a real time view of someone’s circumstances. A soft credit check does not impact consumers’ credit scores or show up as an inquiry on their credit reports. Our business model is predicated on people paying us back on time – because we don’t charge interest or late fees. So, we have a strong incentive to only lend to those who can shop responsibly and meet repayments. As a matter of practice, Klarna does not report anything – including account information or repayment histories – to any of the nationwide consumer reporting agencies. Additionally, no hard inquiry is performed for Klarna’s interest-free payment solutions, like Pay in 4, or longer-term “Financing” loans with monthly payments made by our partner bank. However, there are increasingly rare instances where a Klarna-related inquiry can appear on a consumer’s credit report if that consumer applies for a branded open line-of-credit product offered by our partner bank. This type of financing solution requires the consumer to authorize a hard check inquiry with the understanding it could later show up on their credit report.

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Question: Since BNPL companies don’t do a hard credit pull, you wouldn’t be able to see how many other accounts shoppers have and how much debt they may have accumulated. Is that correct? If so, doesn’t that prevent you from making an informed decision on their creditworthiness and ability to repay?

Affirm’s response

Our models have been built on more than 1 billion data points, including data from over 30 million transactions and our near decade of operations. Our models are designed to continuously improve and become more precise and efficient with each transaction powered by our platform. Our approach to risk management is core to our business model, and has been proven to lead to low fraud rates, higher approval rates, and low credit losses.

Sezzle’s response

We do not use credit data for underwriting. Creating a sezzle account and using our core solution does not impact customers’ credit score. We verify the user identity and start with small credit limits like secured credit cards. Given the low average order value of $100-$120 for the BNPL sector, it is a good starting point for the customers to get approved, and over time, based on their repayment performance, we increase their credit limit. If a customer can’t service the installments at any time, they can’t place a new order anymore. We’re aligned 100% with responsible lending and consider the risk and loss for sezzle, unlike credit cards.

Afterpay’s response

Afterpay’s platform uses proprietary risk models, our “secret sauce”, which allows us to offer our service without using the traditional credit bureaus. Afterpay never uses credit checks because we’re not a credit company. This approach helps consumers maintain their credit scores. More than 95% of transactions never occur a late fee. Almost one-third of customers make the majority of their repayments ahead of time. These metrics demonstrate the power and value of our approach. Our business model also has many risk mitigation factors built in – with rules that reward responsible spending, including: Low value transactions (average order value $150), purchases paid off in 4 installments (low average instalment payment $37.50), every transaction assessed in real-time, customers immediately suspended from making further purchases if a single payment is late, and payment terms cannot be extended – very short duration installment payments (entire receivables book turns over < 30 days)

Klarna’s response

This is not correct. As mentioned above, we conduct robust eligibility assessment on every transaction using advanced technology and sophisticated underwriting, which includes a soft credit check (which does not impact a consumer’s credit score either at the point of application or in the event of a missed payment), as well as taking into account a number of different factors, including — but not limited to — age, having a good track record of paying bills, type of product purchases, time of day and consistency between shipping and billing address. Every time a customer selects one of our products, we reassess their suitability to use our services. Additionally, if a customer misses a payment, we take steps to contact them to bring their account up to good standing. If that fails, they are unable to use Klarna until a payment is made.

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Question: Some critics fear expanding credit to people with little cash or credit — especially during the pandemic economy — can lead to another debt crisis. What’s your response to that concern?

Affirm’s response

We approve consumers only for what we believe they can comfortably afford to repay. The reason our technology is significant is that we use machine learning to make underwriting

decisions. This means we are looking at someone’s credit history and repayment history differently than a standard credit card. We train the algorithm to learn from our history over time. However, rather than a credit card that issues an open-ended line of credit we are underwriting each individual, and each individual transaction, which allows us to be more precise. Our net charge off rates were approximately 1% for the period ending June 30, 2021.

Sezzle’s response

Sezzle promotes safe spending by guard railing shoppers: Sezzle users cannot complete an additional purchase if they have a failed transaction on a previous order. In doing so, we want to provide a safe and transparent approach to credit. We like to think of BNPL as training wheels in developing a responsible approach when entering the credit world. Not only saving money but promoting financial independence and empowerment.

Afterpay’s response

Our business model was created with customer protections front of mind. We are not a loan, never charge interest, hidden fees, don’t do soft or hard credit checks. More importantly we never upsell the consumer on a credit product. We offer one product to our consumers and make sure it’s done really well.

Klarna’s response

Klarna exists to provide consumers with an alternative to predatory traditional banking and credit systems, which makes the majority of their profits on the backs of customers stuck in high percentage interest payments and made more than $12 billion last year from overdraft fees. In contrast, Klarna’s business model is more consumer-friendly by design, operating primarily on merchant fees and taking on all of the credit and fraud risks of every transaction. We have limits in place to ensure that a customer cannot get into large amounts of debt using our products. Every time a customer makes a transaction using Klarna we re-assess their ability to repay and evaluate if the product which they wish to use is suitable for them at that time. We recognise that people’s financial circumstances may change and therefore do not lend to everyone or offer an open line of credit. We also have a dedicated team who work with customers in financial difficulty to find a solution that is appropriate for them. The majority of our customers make payments on time and use Klarna to manage their finances and budget in a safe and sustainable way.

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Question: Does your company have a process to identify potential issues and reign in consumer spending? If so, can you explain?

Affirm’s response

We can efficiently and quickly adjust our models and products at a very granular level. Our proprietary technology is custom-built from the ground up, so we don’t have the constraints

of legacy systems. We closely track and monitor repayment performance to ensure both the integrity of the risk scoring models and to measure possible changes in consumer behavior.

Sezzle’s response

Sezzle promotes safe spending by guard railing shoppers: Sezzle users cannot complete an additional purchase if they have a failed transaction on a previous order. In doing so, we want to provide a safe and transparent approach to credit. We like to think of BNPL as training wheels in developing a responsible approach when entering the credit world. Not only saving money but promoting financial independence and empowerment.

Afterpay’s response

Responsible spending rules and consumer protections are built into the service. This includes automatically pausing an account if a single payment is late. These rules help ensure customers never revolve in debt. We do offer customers the opportunity to change payment dates as part of our hardship policy – which can be accessed by contacting our customer service.

Klarna’s response

To ensure safe spending practices, each new transaction is evaluated by our system before we approve it, and we have limits in place on how much shoppers can spend. These limits are in place to ensure a customer cannot accrue large amounts of debt using our products. Every time a customer makes a transaction using Klarna we re-assess their ability to repay and evaluate if the payment option they wish to use is suitable for them at that time. Klarna has several checks in place so customers don’t miss their payments. At checkout, a payment schedule is clearly laid out so customers know when they will be charged with automatic payments made via their debit or credit cards until the full balance is paid. Additionally, Klarna sends additional emails and in-app reminders so customers are on top of their balance and payment schedule. In instances where we are unable to collect a scheduled payment, we immediately contact the customer to let them know there was an error in processing payment and asking them to try again. If that effort fails, only then will we issue a late fee (up to $7.00 and capped at a maximum of 25% of the past due installment, subject to applicable law.) We then add that missed payment into the next scheduled one and the customer is unable to use Klarna again until the balance is paid. Moving forward, we also limit that customer’s use of our payment programs.

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Question: What happens if a customer simply stops paying?

Affirm’s response

If a customer stops paying it would impact their ability to use Affirm in the future. As noted by the delinquency chart I shared, our DQs have averaged approximately 1% for FY 2021.

Sezzle’s response

If you miss a payment with Sezzle and are more than two days late, your account will be temporarily de-activated. You won’t be able to make more purchases until you re-activate your account and pay a $10 fee. Any outstanding amounts roll over to your next payment date.

Afterpay’s response

95% of customer payments are made on time. If a customer goes late, we send them several reminders and try to work with them to collect repayment. That customer that goes late, cannot use our platform until repayment is made. This approach has shown to be the best incentive for customers to make their payments on time. In certain circumstances, we may work with third party agencies to try to collect the funds. We only work with agencies with a light and consumer-friendly approach that try to collect via email (no outbound collections calls or texts). Regardless, we do not report issues to the credit bureaus.

Klarna’s response

We encourage customers who are struggling to pay to get in touch with us to agree to a repayment plan that works for them. We want to make it as easy as possible for people to contact us, so we operate on a wide range of channels — 24/7 chat in app, email or phone. As a last resort, if after repeated attempts at trying to contact a consumer who has fallen behind on their payments, we are still unable to contact them, we reserve the right to refer them to a collection agency, but there are still no additional fees or interest charges passed to the consumer.