Black Friday shopping makes Klarna and Affirm extra dangerous

The other day I wanted to buy my first big Christmas gift of the year and there it was on the checkout page: Do I want to split this purchase into four simple, interest-free payments?

Parting with a smaller amount of money to get something you want sooner is a compelling offer. So compelling that half of all shoppers in the United States want to use so-called buy now, pay later (BNPL) services for Christmas shopping this yearaccording to a PayPal survey. The same survey found that one in four Millennials and Generation Z regularly use payment options like Affirm and Klarna. These are the same young people who are I'm having a hard time finding a job, Difficulty paying overdue student loan billsAnd Dealing with rising food prices. That could be why things felt so dark at DoorDash announced a partnership with Klarna Earlier this year, it ushered in an era of people taking out loans to pay for groceries.

The more affordable it becomes the dominant theme of American politicsThe holiday shopping season feels different this year. Of course everything is more expensive. But with BNPL options being offered by everything from fintech startups to major banks, it's also easier than ever to finance purchases you couldn't otherwise afford. Meanwhile, the Trump administration has removed some of the guardrails This opaque lending industry leaves consumers more vulnerable to unexpected fees and endless debt. Some are even warning that the situation is starting to become very precarious like in the early days of the subprime mortgage crisis that led to the Great Recession.

“BNPL lenders are not currently required to do this […] Determine whether consumers can afford their BNPL loans,” said Nadine Chabrier, senior policy and litigation counsel at the Center for Responsible Lending. “There are currently no checks and balances for borrowers who take out multiple BNPL loans at the same time, which can lead to over-extension.”

If you've seen it The big short film or simply followed the progression of history, that sounds pretty worrying. But before I get too carried away warning of an impending economic crisis, let's take a look at how these small loans work.

Buy now, pay later, hurt forever

In the early days of the industry, you would most often come across a BNPL option on the checkout page of an e-commerce site, probably one that sold luxury goods. The ability to pay in installments, often without interest, made it easier for consumers to pull the trigger on high-priced items, so stores quickly adopted this function. Lenders would make money by taking a small portion of the purchase price, and they would also charge the consumer late payment fees.

Venture capital-financed fintech startups were pioneers. Affirm was founded in 2012 and helped bring BNPL mainstream, and Klarna joined the market in 2015. The pandemic accelerated the industry and the dollar amounts borrowed exploded According to a Consumer Financial Protection Bureau (CFPB) report released this year, the price rose from $16.8 million in 2019 to $180 million in 2022. The average loan at the time was $135.

A big problem, as Chabrier pointed out, is that BNPL lenders typically don't have to check whether you can afford to take out one loan, but instead allow you to take out several at the same time, a practice known as “loan stacking.” These factors could explain why late payments are so common. More than 40 percent of BNPL users say they do made a late payment an increase of 34 percent last year, according to a Lending Tree survey last year. Now more than 20 percent say they have taken out three or more loans at the same time, and a quarter of respondents said they have taken out a BNPL loan to buy groceries.

This is a good time to point out that not all of these loans are interest-free. Both Confirm And Klarna say their interest rates can be as high as 36 percent (Klarna's peak is actually 35.99 percent, but it's fair to round up). This is still much lower than short-term loans you can get up to 600 percentbut it is much higher than zero.

Now back to the impending financial crisis. Until recently, most BNPL loans were not reported to credit reference agencies, meaning there was very little insight into who was borrowing and at what interest rates. During the Biden administration, the CFPB attempted to regulate the industry by issuing a rule that treated BNPL lenders like credit card companies, but the Trump administration repealed this rule Earlier this year. Around the same time, the company that determines the FICO score, a measure of how likely someone is to repay a loan, made the announcement would introduce a new type of score The BNPL debts were taken into account. However, these values ​​can currently only be viewed by lenders and not by consumers.

The BNPL industry remains largely unregulated at a national level. All consumer debt is now becoming a financial product in its own right. Elliott Investment Management just closed a deal to purchase $6.5 billion worth of debt from Klarna as the fintech company expands its business into larger, longer-term loans for consumers. Affirm had sold nearly $12 billion worth of securitized debt from June.

In a recent TechCrunch articleConnie Loizos explained in bleak terms what BNPL companies do: “Slicing up risky consumer debt, selling it to investors who think they understand the risk profile, and creating financial techniques that obscure where the real risk lies.”

Again, it sounds a lot like the subprime mortgage crisis. However, it is unclear whether we should use such big words for what is happening at this moment.

“It would be premature to say there is a crisis,” Chabrier told me. “While it is possible, we do not know enough about the scale of BNPL borrowing to say such a thing.”

On an individual level, we can say that BNPL is becoming more and more dangerous. The industry “has built an insane new consumer culture – and trapped users in a vortex of debt,” it says a New York Times Magazine feature on people who just started shopping, missed the fine print and got into real trouble.

As you begin this holiday shopping season, read the fine print. Or better yet, don't buy now and pay later. The US economy may thank you.

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