With surging inflation sparking concern about household debt across the globe, some of the most widely used forms of consumer borrowing are facing increased scrutiny.
But here’s the thing: I believe that not all consumer lending is created equal.
Some commentators have recently conflated buy now, pay later (BNPL), where shoppers borrow the amount of a purchase at checkout, and payday lending, the practice of offering short-term loans to borrowers at high rates of interest.
As someone with deep knowledge of both the risks of payday lending and the immense benefits of BNPL for consumers and retailers, I believe this confusion is misguided and dangerous—and worth addressing in detail.
Beyond their low barriers to lending, these two industries are vastly different in motives, methods and impact on individuals.
BNPL allows customers to divide up the cost of purchases into installments, typically without facing interest or payment fees. As a lending method, it’s quick, convenient and easily accessible, sometimes with no hard credit check involved.
Payday lenders, meanwhile, offer borrowers short-term loans at very high rates of interest (often in the triple digits) that fall due on their next payday, within a few weeks.
They can be readier lenders than banks, even to borrowers with weak credit histories. While this may be music to the ears of those in dire situations, when these loans aren’t repaid, they typically rollover, amassing interest and late fees. The debt can snowball, and borrowers can fall into a devastating payday loan trap: a self-reinforcing cycle often difficult or impossible to break. Many payday loans are made to individuals who take out the same loan again and again.
Both types of borrowing have boomed in the past couple of years—for different reasons.
BNPL, already popular before the Covid-19 pandemic, grew exponentially as lockdowns and other restrictions triggered an online shopping boom.
Australia-based BNPL provider Afterpay saw a 200% jump in users between mid-2019 and mid-2020, while Swedish rival Klarna added more than 1 million customers in the summer of 2020 alone.
The bumper growth continued into 2022. BNPL’s popularity, particularly with younger borrowers, has attracted a rush among big corporations—including Mastercard, PayPal, Goldman Sachs and Apple—to join in.
Payday lenders also had a prosperous pandemic, but they were capitalizing on a different trend: financial insecurity and misfortune among workers hit by pandemic-linked disruption in many industries.
While more recent demographic data on who turns to payday lenders is not available, based on past research, borrowers tend to earn less income and use the money for routine expenses such as utilities, rent and food. The fees are hefty, in one calculation based on the average amount borrowed and interest, it can cost $520 dollars to borrow $375.
Although BNPL also appeals to younger borrowers, they tend to come from across the income spectrum. According to a 2020 poll, 75% of those surveyed who used BNPL for a purchase had enough cash in their banks to pay in full but saw installment borrowing as a low-cost, low-risk way to absorb the expense.
In an effort to curb high-interest borrowing, many U.S. states have capped the fees payday lenders can charge. But even in states with caps, rates still run far higher than those charged by banks or credit card providers (never mind zero-interest BNPL lenders). A $15 fee per $100 on a two-week payday loan, for instance, equates to an annual percentage rate of almost 400%.
In states without ceilings, payday lenders can and do charge astronomical sums—more than 500% in states like Mississippi, Montana and North Dakota, as well as more than 600% in states like Texas, Utah, Idaho and Nevada.
Discouraging Debt Dependence
There can also be consequences for BNPL users who miss payments, but they are typically far less impactful. Many providers have also taken steps to discourage debt dependence.
Klarna charges a late fee of up to $7, depending on the amount, and imposes restrictions on further use by the delinquent consumer. Klarna says less than 1% of its users fail to pay back what they owe.
At Affirm, there are no late fees, but tardy payments can affect the customer’s chances of borrowing in the future.
Industry leader Afterpay charges $8 or 25% of the transaction price, whichever is lower, for late settlement. It has also set up a “hardship policy” and invites customers to contact the company to discuss options—such as a new repayment plan—if they run into financial difficulties.
PayPal last year dropped late fees for its U.S., U.K. and French BNPL offerings, bringing them into line with Australia and Germany, along with many rivals in the space. However, a missed payment may affect credit scores.
There are big differences in rates of late or nonpayment between the two industries.
Many U.S.-based payday loan borrowers cannot pay the loan in full requiring a rollover loan to make up for the tardiness. In a survey of BNPL users, one in three respondents admitted tardiness on one or more installments.
In the U.K., the Financial Conduct Authority has convinced several BNPL providers to clarify terms and conditions to assuage concerns over risks to consumers.
In Australia, the industry itself has introduced consumer protections through the BNPL Code of Practice. This voluntary code is overseen by the Australian Finance Industry Association, or AFIA, and big players in the industry such as Afterpay, Klarna and Zip are among its signatories.
No matter how they borrow, consumers have a responsibility to spend within their means and keep an eye on their monthly payment commitments.
But whereas BNPL can help shoppers bridge a short-term budget gap—oftentimes without interest or fees, payday lenders tack on high interest rates that can encourage debt dependency.