What's Behind the Boom in Buy Now Pay Later

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1:49Hello and welcome to another episode of the Oddbots podcast. I'm Tracy Alloway. And I'm Joe Weisenthal. Joe, I have a confession to make. Yeah. I do a lot of online shopping. Like a lot. Really? More than is healthy, probably. More than I realized from looking over your shoulder in the office and asking you what you're looking up. Because I do do that and you never like it, but I still do it. No, because sometimes I am in fact shopping online in the office. But a few years ago, I noticed a phenomenon, a change when it came to online shopping. You know what that was? I can guess. Yeah. All right.

2:23All of a sudden, whenever I was checking out, you would get an offer, a little button usually that would say, do you want to take a buy now, pay later option? And usually it's with a company like Klarna or Affirm or something like that. They're everywhere now. So like I've certainly seen all these buttons. I've never used it. I don't really know why I haven't because like why shouldn't I spread out? Why shouldn't I like for real? Like my understanding is that the core of the business model works is that there's no like formal interest. Right. So if you make a hundred dollar purchase, you get to spread it out, say, in four payments of twenty five dollars.

3:02And so whether it's$100 right now or$100 in four months, it's the same from the end buyer, which, of course, in theory, because there's a time value of money, is not intuitive. But the idea is that the retailer implicitly pays the interest because it's a form of customer acquisition. And so the retailer is implicitly willing to take$100 or whatever over X period of time rather than all at once in exchange for essentially making it easier for customers to buy. But from the customer perspective, like you or me, who presumably have the money to buy what we're purchasing, I still don't get why we don't all use buy now, pay later, because why not spread out our purchases further out into the future?

3:42You know how Rebel Wilson described it in a firm commercial? I didn't. I don't. I haven't seen it. Like eating a tub of ice cream but spreading out the calories over four weeks. Yeah, exactly. Why don't we? It's still 600 calories, right? Yeah, but— That's the issue. But I think, OK, so this is obviously a nuanced subject. So clearly 0 % interest doesn't sound like a problem. But obviously, if you fail to pay, you pay a penalty fee. Then the penalties are building up. Right. So there's that. But the other issue with some of these buy now, pay later items, and it's really interesting. I kind of think about this as a parallel to the private market and credit.

4:20So this idea that there's this like whole world of additional credit or leverage that we don't actually have very good data on. Yeah. And that is growing. Right. I think that is the key. So here's how I see the issue, which is that if I could have a tub of ice cream and spread out the calories over four months, I would certainly do that. That sounds pretty great because I burn a certain number of calories in a day. And so if I had four months to burn them, that would be far more efficient. But the flip side is, well, I would eat more ice cream. So I would eat four times as many tubs of ice cream in that given day, knowing that I have this four-month calorie budget.

4:58And so then you still get the question of like, OK, maybe there's not a formal interest or maybe there's penalties, but I'm buying a lot more with today's buying power. And that may still yet prove to be unsustainable to the end consumer, even if it doesn't formally clock as what we measure as consumer debt. Here's the added layer. Let's say you're trying to lose weight or trying to be healthy and you have like a dietician. Imagine eating the ice cream, but him never knowing that you're eating the ice cream. Right. Like this is. Well, I lie to my doctors all the time. I mean, I'm used to that.

5:31OK. All right. Rather than us debate this, we do, in fact. How much didn't you? Well, you know, like once a week, I like go through a three milligram thing. I did actually quit. And I'm saying that. You told me this this morning. You said you were not going to have any more Zins. For the rest of my life. And I think I would take the opposite side of that bet. But now you've committed in public. Yeah, in public. So we'll see how it goes. Okay. Rather than us talk about this, we do, in fact, have the perfect guest. We're going to be speaking with Julie Morgan. She is a president of the Century Foundation, formerly at the Consumer Financial Protection Bureau, the CFPB, where she thought a lot about the buy now, pay later phenomenon.

6:11on. So we're going to get some of her thoughts right now. Julie, welcome to the show. Thank you. I'm so excited to be here. So how did this happen? Like, how did this business model actually come about? Because it felt very sudden to me. But on the other hand, I was outside of the US for a long time. So maybe it was quite gradual. I'm really excited to answer this question for a number of reasons, including the way that you all introduced this, because you spent a lot of time talking about Buy Now, Pay Later as this pay in for zero interest, maybe like no fee or low fee model. And we did see that model arise during the pandemic and become a much more salient part of the way consumers were paying for goods during the pandemic.

6:51And so if I could take you back to kind of those early years at the CFPB where we're coming out of the pandemic, we're seeing this rise in Buy Now, Pay Later. You know, regulators and researchers started to investigate this to understand what it meant for consumers and what the risks were. And I think there were kind of two fundamental assumptions about Buy Now Pay Later at that time. One was just what we said, it's a pay in for, no interest, low or no fee model. And then two, people were using this in kind of the like, what I think of as a stereotypical Gen Z kind of way. They were using it to finance a purchase that was slightly larger or more extravagant than what they would have bought.

7:31And it was usually on something like a purse or an item of clothing. What we found over time is that both of those assumptions turned out to be wrong, right? So number one, what we're seeing right now as Buy Now Pay Leader and calling Buy Now Pay Leader is not, in fact, always that pay-in-for-no-interest product. And in fact, many of the companies that we associate with Buy Now Pay Leader, like Affirm or Klarna, are mostly not offering that product. So a firm says that product is only 20 percent of their business. The rest of their business is what I would think of as like a like point of sale loans or short term installment loans with interest rates ranging from, you know, 10 to 30 percent and terms that range from 30 days to six or 18 months.

8:16So it's buy now, pay later, but it's more like just a formal loan. Yeah, I mean, it's payment and installment and there's a schedule, but also there is a nominal interest rate that's visible to the consumer. Exactly. And I think it is buy now, pay later in the sense that any loan, including your mortgage, is buy now, pay later, right? So they've kind of kept this marketing that I think was really appealing to consumers and that sort of soothed regulators that these products were fairly low risk and then started shifting that into these products that look very different. OK, whether we're talking about the new products or the sort of the traditional BNPL, the way Tracy and I described it in the beginning, currently, what kind of collection of data, like when that happens?

9:02So we know like credit card data gets collected. There is public statistics about just the sheer volume of credit cards. What do we have right now in terms of where this gets slotted and how it's collected as data? Yeah, we don't have a ton. So we have a couple of different ways of looking at Buy Now Pay Later. Most of it is through government sources. So the Federal Reserve and the CFPB have the ability to pull data from the companies. And if you look at the CFPB's reports on Buy Now, Pay Later, that is what they're doing. They're pulling transaction level data through market monitoring orders.

9:33That's not. But when you say market monitoring orders, just to be clear, the companies are compelled to regularly update the CFPB with some level of data. They're compelled to provide data. The regularly piece is not part of it. So this tends to be a one-off, right? We don't have a consistent stream of data coming from the companies. And so that gives us like a small window into what's happening in the buy-now-pay-later space, but it's really not enough. And then we have survey data. And that's where you see LendingTree and Axios and others asking consumers. And I think it's important to understand that there, you're just kind of getting what the consumer thinks they have.

10:11And it really inhibits our ability to get at, are you using Pay-in-4? Are you paying interest? And all those things. How does Buy Now, Pay Later fit into private credit scores like FICO, right? Because I imagine, you know, if you're applying to a bank, they're going to look at your FICO score if you want something like a mortgage. And even though Buy Now, Pay Later seems to be for mostly smaller items at the moment. So maybe you owe like a couple hundred or something via a firm. Maybe you also owe a few thousand via Klarna, right? And I imagine if you're a bank using FICO scores, you would want to know that information.

10:48Yeah, so we don't know this information right now. FICO announced recently that they plan to start using Buy Now Pay Later as part of their scoring model. And we've seen the companies be extraordinarily resistant to that. So Klarna and others are saying that they're not going to turn over data until they get certain assurances from FICO about how that data is going to be used. So what we have right now is kind of snapshots in time to understand how people are stacking, you know, Buy Now, Pay Later on top of credit card debt and on top of other products. And the research that we have there, which is somewhat limited, does suggest that people are stacking this.

11:25It tells us that about 60 percent of the people who are using Buy Now Pay Leader have a subprime credit score. It tells us that they are mostly using it on top of credit card debt. And it's also suggesting that before people take on Buy Now Pay Leader, there's a slight uptick in their use of their credit card. So there's a suggestion that it's really like you're maxing out one form of debt and then taking on another. I just looked up the Q2 New York Fed household debt report. I think it just came out a few days ago. It must have. It's Q2. Anyway, it says there's$1.21 trillion in total credit card balances outstanding.

12:01Do we have something that we have a guess for? What is the number of BNPL loans of any form currently outstanding so that we can benchmark that against credit cards? We have numbers that are reported by the companies. We don't have data that is reported by a government source like that. I think that the best we have is that the transaction volume is around$116 billion. And that's up from about 13.8 billion in 2020. So this is growing pretty rapidly. So it's a non-zero. I mean, it's not like clearly like still like a fraction of credit cards, but this is beyond a rounding error. That's right. OK.

12:37Do we have any sense of how usage patterns have changed? So, for instance, you know, during the pandemic, did we see an uptick in buy now, pay later use as people were struggling because they didn't have jobs or had short term cash flow issues? Has it come down since then? We're seeing an uptick in people's use of buy now, pay later, and we're seeing shifting patterns of what they're using it to purchase. So I think I said earlier that there was this assumption that people were using this to purchase clothing or other kind of luxury goods. And, you know, even back in 2022, when the CFPB put out its first report here, we saw that that wasn't true.

13:13People were using buy now, pay later for things like groceries and education costs. The surveys that have come out recently show that that's growing. So there was, I think, an Axios survey and a LendingTree survey. They showed somewhere between 14 and 25 percent of buy now pay later users are using it to purchase groceries. They're showing that a bigger percentage of people are using buy now pay later for medical and dental costs than for the things people might assume stereotypically. It's used for like dining out or ordering in or even like purchasing concert tickets, things like that.

13:52Thank you.

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15:46Go to public.com and earn an uncapped 1 % bonus when you transfer your portfolio. That's public.com. Paid for by Public Investing. All investing involves the risk of loss, including loss of principal. Brokerage services for U.S.-listed registered securities, options and bonds, and a self-directed account are offered by Public Investing, Inc., member FINRA and SIPC. Crypto trading provided by Backed Crypto Solutions, LLC. Complete disclosures available at public.com slash disclosures. Is it bad? I mean, like, you know, it seems like people are using buy now, pay later for dental or they're using it for groceries or whatever.

16:17And like, you know, the idea that people are obviously stressed and have to spread out or borrow money to make those purchases is obviously I guess there is an inherent angst about that because these are human essentials. But is it really per se bad or is it just like, no, this is like yet another tool that people have to sort of, you know, smooth consumption and so forth? I think it's bad that we're seeing an uptick in the use of credit products to pay for essentials. That's not to say that buy now, pay later is particularly the enemy there. But, you know, this is part of the reason I've been interested in consumer credit overall is that, you know, we see these broader changes go on in the policy space.

17:00In particular, recently, we've seen Donald Trump and Republicans in Congress push through a bill that cuts Medicaid, cuts food assistance, makes education more expensive. And the availability of consumer credit products that are kind of waiting in the wings there blunts our ability to really understand what those changes mean. So, you know, we know that the Medicaid cuts will result in people having more expensive health care. But we need to be looking at the fact that that's going to result in buy now pay later loans. It's going to be an opportunity for medical credit cards from places like Synchrony with Care Credit.

17:35And so it's relevant to our overall economic situation. It's relevant to the kind of like what I think of as like a silent financial crisis that's happening for the vast majority of families in the United States. But it's not tracked. You know, we've been talking about buy now, pay later really not being tracked. But the overall sort of like consumer credit conditions for families are really not tracked and talked about in that way. We see economists going on TV talking about consumption and CPI and GDP, where families are kind of sitting around the kitchen table talking about Klarna and Affirm and Sally Mae and Navient.

18:14When you were at the CFPB, how were you thinking about Buy Now, Pay Later from a sort of regulatory perspective? Yeah, so we were looking at the risks of the products and then we were kind of trying to look, you know, we've had this phenomenon with consumer credit products across the board, not just specific to Buy Now, Pay Later, but it was really evident at CFPB that you have these sort of like new entrants into a market whose products are framed very differently than a traditional consumer credit product. And it's often part of the marketing pitch. It's like, we're not alone. We're not equity.

18:46We're this totally different thing. And it preys on consumers' hesitance to use debt. And then also, you know, this idea that we might float above any regulatory scheme. So for Buy Now, Pay Later and for these other products like earned wage access or income share agreements, we were looking at what is this under the law? And with Buy Now, Pay Later, particularly the products where Klarna or Affirm is offering basically a digital or physical card where you can make repeated purchases, where you have an overall limit. It starts to sound like a credit card, right? And so CFPB's initial approach on regulation here was to really just say, you've got to follow some of the fundamental basics that apply to the product that you are.

19:31And so that was really meant to help people with some of the real kind of basic consumer protections around managing disputes and getting accurate billing statements. The other thing CFPB was doing was on the enforcement and supervision side. So really taking a look at these companies the same way we do any other financial institution and making sure they're following the law. And I think it's important to talk about that piece because we've seen the Trump administration pull back on the proposed regulations, but we've also seen them pull back on enforcement. They specifically said they would deprioritize buy now, pay later in enforcement.

20:05And so there are these other real basics that we're seeing fall apart. You know, if you look at what consumers are complaining about right now, they're saying I had auto pay on my, you know, my Klarna or my after pay and I tried to take it off and the company continues to charge me. These are like really basic questions of whether the companies are following consumer financial laws and, you know, CFPB is just off the job. So you mentioned that in the research prior to someone beginning to use BNPL, there is an increase in their credit card usage, right? Why does someone flip over? Like, why doesn't – so some of these purchases, what is insufficient about the existing credit card system?

20:47Is it that they're hitting their credit limits? Or what is the situation such that then BNPL becomes more attractive? Yeah, I think we need to take a deeper look at credit utilization because I do think there are people who are flipping over and they're using their available credit balance and then they're shifting to buy now pay later. But I think there are a lot of other people who are just trying to juggle their essentials, their groceries and their kids' back-to-school clothes. And they're doing it through whatever feels like the most convenient payment method. So the Buy Now, Pay Later companies have made a real effort at being that convenient payment method, both through kind of point of sale but also through their apps.

21:26So they're pushing their users towards an app that both makes it more convenient to make the payment, but also pushes you advertisements for different products. And so I think we see people brought in there. But you mentioned earlier why you don't use Buy Now Pay Leader. And I do think it's important to mention. Great question. We could do a half hour on your personal finances. But I think it's important to know that even while there's a big percentage of people using this to cover basics, there is kind of a split in buy now, pay later, where if you talk to consultants who look at this really closely, they're seeing people like you or I who can.

22:03I'm making an assumption about your finances. I get paid well. Okay, cool. You know, like you or I who can make a purchase, but it's a painful purchase. You know, maybe it's like a new television or something that you just don't want to pay up front. So there are people using it in that way, too. Interesting. You mentioned ease of use, and I think this is really key. What are the conversations like with retailers? So like what's the pitch that buy now, pay later platforms are going to make to, I don't know, a Walmart or whoever to kind of plug directly into their websites? Yeah. So the pitch is basically basket sizes and then overall transaction volume, right?

22:40So they're showing that they're getting the retailers about 10 % more in terms of the basket size. So the amount of things that people are purchasing. And then some of the companies are reporting up to 80 % more in terms of the actual transaction. So that's pretty significant for retailers. And I think it is what is propelling retailers to cut deals with Klarna or Afterpay and to pay the costs, which are higher than interchange on a credit card. So in many cases, you know, we're looking at costs that are somewhere between 1 % to 8 % of the transaction plus like a flat fee that might be like$0.30 per transaction.

23:17So it's pretty significant. I think the other part of the pitch is, and this is one of the pieces that was really kind of consuming a lot of our attention at CFPB, is the ability to use people's data to drive those purchases. So I think if you're a merchant looking at those big fees, if you're Walmart or Amazon or whoever, you're not just saying like, let me put this in Klarna or a firm's hands to hope that people use it more. But let me use the data I have on hand to try to drive more purchases. And like a company that has a lot of information about what I like to buy and a lot of information about how much money I have to do it has like a pretty potent set of data to help drive those purchases.

24:00So I think that's part of the appeal for margins as well. Do we have a way of essentially measuring from the consumer's perspective a sort of like for like interest rate that they payment? Because as you described, like in some cases they're clear, right? In some cases they're more embedded because it's free for four months, but then there's like a penalty. In some instances it's this thing that looks like a credit card, but maybe structurally there's a different way of getting from point A to point B. like, can we measure like, okay, if this were a credit card payment with a 15 % rate, this is the apples to apples compared, you're paying 18 % or 12%.

24:39Like, are we able to, are you able to do that? Me personally, I'm not able to do that. But, you know, at the CFPB, we did do that on certain products. We didn't do that for buy now, pay later. In many cases, because the products we were studying had almost no cost, right? They were no interest and no fee. Maybe they had a late fee that might kick in. But remember, where they're requiring auto payments, which most of the companies are, those late fees are less likely to be incurred. But I think the sort of relevant thing is to understand how much people are paying overall in excess fees and interest for the goods and services that they need.