Buy now/pay later loans are becoming riskier: Consumer Reports

Buy now/pay later loans boomed during the pandemic by enabling shoppers to stretch their budgets through simple advances repaid in four installments with no interest. But BNPL loans recently have moved into far riskier territory, according to a new Consumer Reports white paper. 

About one in 10 BNPL loans now carry an interest rate, and some BNPL loans carry interest rates as high as 36.99% and large loans can be extended for up to 60 months, with late-payment fees of $30, making certain BNPL loans more expensive than credit card financing, Consumer Reports said in a Thursday press release announcing its recent research findings. 

Affirm, Klarna, PayPal and Sezzle are among the BNPL lenders that offer loans with higher interest and longer terms. Because these companies' marketing and branding tends to emphasize the simpler "pay in 4" model, consumers could be misled, said Jennifer Chien, senior policy counsel for financial fairness at Consumer Reports.

"These new terms are confusing to consumers, because for so long BNPL has been heavily promoted as a free service that's fast, convenient and doesn't affect your credit score. Now there's a range of different products marketed as BNPL that are longer-term, that carry interest and may affect credit scores, creating a disconnect between the overall marketing message and what consumers are experiencing now," Chien said.

One reason BNPL loans gained traction so fast was the fact that installment loans with fewer than five payments and no finance fees aren't subject to provisions of the Truth in Lending Act, which gave BNPL fintechs the opportunity to build significant momentum without direct regulatory oversight. 

But as the pandemic-fueled online shopping frenzy cooled, key BNPL providers reported rising consumer delinquencies. Some providers in the BNPL niche began to extend the terms of certain loans, exploiting the lightly regulated environment at consumers' expense, according to Chien.

"It's not clear that BNPL lenders are violating laws, but evidence is mounting that consumers are confused about the actual terms and fees associated with many BNPL loans," she said.

The Consumer Financial Protection Bureau is expected to issue official regulations addressing the BNPL sector, but the agency has not stated when those rules would come, even as BNPL loans rapidly evolve.

The CFPB initially flagged its concerns with BNPL loans in late 2021, when it launched a market inquiry into the business practices of Affirm, Afterpay, Klarna, PayPal and Zip. In the 82-page follow-up report that the agency published in September 2022, the CFPB said it planned to develop guidance or rules to cover gaps in the BNPL arena. CFPB Director Rohit Chopra said the agency's work will bring BNPL lenders' practices into alignment with the Credit Card Accountability and Responsibility Act of 2009. 

When Apple Pay Later rolled out its BNPL product this year, its terms seemed to anticipate the approach of more-restrictive industry rules. Apple Pay Later users can borrow a maximum of $1,000 only using a pay-in-four model. Unlike most other BNPL lenders, the tech giant will automatically report users' borrowing activity to credit bureaus.

As of December, 2022, 21% of U.S. consumers said they had used a BNPL service, according to Consumer Reports' white paper. The top reason BNPL users cite for using BNPL is to make a purchase they couldn't afford otherwise, Consumer Reports found in a survey of 2,013 U.S. BNPL users conducted in August 2022.

In a separate policy briefing released Thursday along with its 38-page white paper about rising BNPL loan risks, Consumer Reports recommended that the CFPB should establish new rules for this largely unregulated market so consumers are treated fairly and aren't surprised by interest charges and other unexpected costs when they take out a BNPL loan.

Yonkers, New York-based Consumer Reports advises the CFPB to require BNPL lenders to provide enhanced disclosure and transparency about the difference between interest-free and interest-bearing BNPL loans, and develop a format to describe features and pricing for pay-in-4 BNPL loans.

The CFPB should also ensure that BNPL providers assess a consumer's ability to repay and require BNPL lenders to report customers' payment history to credit bureaus, while also creating a framework for responsible treatment of BNPL loan data. 

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The rapid evolution of buy now/pay later loans

December 27, 2022 9:00 PM

Regulators should also create guidelines to protect consumers who want to return items purchased through BNPL loans, which don't necessarily have an established chargeback process, Consumer Reports said in the policy briefing. 

While some BNPL firms said they are beginning to report BNPL borrowers' activity to credit bureaus, there is no industry requirement to do so, and there should be a consistent approach, Consumer Reports said in the white paper. 

While it's unknown when the CFPB will act, there's a growing expectation among consumer advocates that the agency will soon address many of BNPL industry concerns in proposed regulations, according to Chien.

"As more BNPL lenders extend the terms of BNPL loans but continue to market them as simple 'pay in 4' loans, consumers are clearly confused. We saw this in online focus groups we conducted this year where consumers thought they were buying something with an interest-free loan and it was actually an interest-bearing loan," Chien said.