Most of us will know the feeling of staring longingly at the current clothing item of our desire (close your eyes, and you can probably think of an example), knowing that we don’t have the funds for it.
It used to be that you had to wait to get your paycheck to get that dopamine kick. But when modern Buy Now, Pay Later (BNPL) fintech companies exploded into the market, buyers didn’t have to wait any longer. With companies like Sweden’s Klarna, Australia’s Afterpay and Zip Co, and America’s Affirm, they could make the purchase immediately.
How do they work? BNPL companies offer consumers the option of receiving the goods before they have made payment. Then they issue refunds (often interest-free) – one of the many perks that encourage customers to use their services.
“BNPL is also attractive to consumers because it claims to have no interest charges,” says Associate Professor Rob Nicholls, an expert in the financial services industry and regulatory space. “This contrasts with credit cards which can earn around 20% interest.”
Dr Natalie Oh, UNSW Business School has expertise in behavioral finance and has worked in the area of personal debt and decision making. She says BNPL might seem like a good idea for consumers who want to better manage their cash flow (for example, if you want to match cash inflows and cash outflows).
“In addition to offering interest-free purchases, there is potential for discounts, coupons and other rewards provided by BNPL suppliers.”
But as concerns grow around the cost of living, should we worry about the relatively unregulated space? What should consumers be aware of? And what impact would regulation have on these booming businesses?
Is buying now, paying later a good idea?
Teacher. Nicholas: Buy Now, Pay Later or BNPL products were first introduced at a time when interest rates were very low. It allows clients to manage their cash flow over a short period (usually eight weeks). For people who are paid fortnightly, this means that expenses can be matched to income.
BNPL is really a replacement for the typical Australian ‘layaway’ or ‘layby’ where goods are received when money is paid over time. The difference is that the goods are obtained before all payments are made.
Read more: Is it the right time to buy a house in Australia?
What are the disadvantages of buy now, pay later?
Teacher. Nicholas: BNPL is a great system for people who can manage their money well and understand that multiple BNPL commitments mean large refunds. The problem is that the BNPL is not always seen as another source of credit.
Some BNPL providers also charge a monthly fee for accessing the service. This can be a significant portion of payments made if the customer only uses Buy Now, Pay Later products for low cost goods and services.
Dr Oh: The disadvantages for BNPL also include the potential for overspending. If you’re late with payments, it incurs fees, and defaulting on payments can leave a mark on your credit history. This means that larger purchases like a car or house could be at risk or you may have to pay a higher rate.
Read more: Is using super to buy a house a good idea?
How do BNPL companies make money?
Teacher. Nicholas: The main source of income for BNPL operators is a commission charged to the merchant (the seller of the goods or services). This can be significantly higher than the equivalent merchant fees for credit cards (up to 6% instead of 2%).
Different providers also have fees, including account maintenance fees, set-up fees, and late payment fees. Some BNPL operators cap their late payment fees. For large BNPL operators, these fees are reported to the Australian Finance Industry Association.
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With the rising cost of living, do you think consumers are more likely to turn to BNPL companies?
Teacher. Nicholas: As inflation rises and interest rates rise in the wake of the pandemic, BNPL looks more attractive as there are no interest charges to pay. However, the same money management issues still exist. There is a much greater risk of going into debt by deciding that food or energy bills should be deferred.
Retailers like Woolworths offer their customers the option to select PayPal at checkout and choose the service’s Pay in 4 option. PayPal’s Pay in 4 payment method works similarly to other BNPL services by dividing the total cost of the purchase into four separate payments due every two weeks. This represents a real risk of going into unmanaged debt.
Dr Oh: Consumers are more likely to turn to BNPL because they need an alternative line of credit. The consumer sentiment of not paying interest on purchase is attractive, and consumers tend to be overconfident that they can pay on time to avoid late fees, which is not always the case.
Further away, according to the ASIC report, in fiscal year 2018-19, missed payment fee revenue for all Buy Now, Pay Later providers totaled over A$43 million, a 38% year-on-year growth previous. This clearly illustrates that more and more customers are falling into the trap of being overconfident that they can pay on time – but the statistics tell you otherwise.
Commentators believe that rising interest rates and increased regulations could be a problem for BNPL companies. Why is it?
It would not be consistent for the RBA to seek to control inflation and for “interest rate pain” to be deferred using BNPL. The RBA believes that there are enough savings that controlling inflation will not lead to a recession.
The BNPL does not fit well into this approach. This means that there is a high probability of further regulatory intervention in the BNPL space. There is also a problem for BNPL operators that the BNPL model was based on very low interest rates. Merchant fees and consumer charges were all designed in this low interest rate environment. It is therefore likely that BNPL operators will have to consider whether their existing model will work in a higher interest rate environment.
Dr Oh: There is an ongoing debate as to whether BNPL should be regulated by credit laws and whether there is sufficient consumer protection for those who use BNPL and other innovative financial products that are on the market. .
Let me put this into perspective.
The majority of BNPL users are millennials who use BNPL as a source of short-term funding. 18-34 year olds make up 61% of BNPL users, with 18-24 year olds making up 23% overall. According to the Household, Income and Labor Dynamics in Australia (HILDA) survey, people aged 15 to 24 have the lowest rate of financial literacy.
This fuels the debate over whether there is adequate consumer protection in the BNPL space, especially for young people and those who are financially vulnerable.
To increase consumer protection around new financial innovations such as BNPL, the rate of financial literacy must be increased.
What does the rising cost of living mean for personal debt levels?
Dr Oh: The rising cost of living means more potential for debt accumulation. To keep up with the rise in prices, you have to either increase your income or find another source of financing, ie accumulate debt.
Although current unemployment in Australia is at the lowest rate in decades, real wages and salaries are not keeping up with inflation. This means that households must find an alternative source of finance to manage the gap using a debt arrangement such as BNPL.
The 2020 ASIC report suggested that 43% of users with a BNPL agreement took out additional loans to meet their BNPL obligations. It will be the likely trend in the future to keep pace with debt payments, which means a snowball effect in the personal debt space.
What do you need to know before going into debt with BNPL?
Dr Oh: Remember the following before registering with BNPL:
It’s easy to overspend. You can commit to spending what you cannot afford.
Fees add up. You are charged for using the service. Know the fees involved.
BNPL can be difficult to manage. If you sign up for more than one BNPL service, it can be difficult to keep track of payments.
BNPL could affect a loan application. Lenders consider Buy Now, Pay Later expenses when applying for a car loan or mortgage.
Late repayments may appear on your credit report. This affects your ability to borrow money in the future.