With a cost-of-living crisis on the horizon, there are risks in the BNPL space. Most of us will know the feeling of gazing longingly at the sartorial object of our desire (close your eyes, and you can probably think of an example), while knowing we don’t have the funds for it.
It used to be the case that you’d have to wait till you received your pay cheque to get that sweet shopping dopamine hit. But when modern Buy Now, Pay Later (BNPL) fintech firms exploded onto the market, shoppers no longer had to wait. With companies like Klarna, Afterpay and Zip Co, and the US-based Affirm, they could make the purchase straight away.
How do they work? BNPL companies offer consumers the chance to receive the goods before they have made payment. Afterwards, they make payment in (often interest-free) repayments – one of many benefits that encourages customers to use their services.
BNPL is also attractive to consumers as it claims to have no interest charges. This is in contrast to credit cards which can incur interest at about 20%. BNPL can seem like a good idea for consumers wanting to better manage your cashflows (for example if you want to match cash inflow with outflow). As well as offering interest-free purchases, there is a potential for discounts, coupons and other rewards provided by BNPL providers.
But as anxieties rise around cost of living, should there be concern around the relatively unregulated space? What impact would regulation have for these booming companies?
Is Buy Now, Pay Later a good idea?
BNPL products were first introduced at a time of very low interest rates. It provides a way in which customers can manage cash flow over a short period (usually eight weeks). For people that are paid fortnightly, this means that the expenditure can be matched to income.
BNPL is really a replacement for the Australian ‘layaway’ or ‘layby’ where goods are received when the money is paid over time. Only difference is goods are obtained before payment.
What are the disadvantages of Buy Now, Pay Later?
BNPL is a great system for people who can manage their money well and who understand that multiple BNPL commitments will mean large repayments. The problem is that BNPL is not always seen as another source of credit. In 2020, the Australian Securities and Investments Commission (ASIC) found that twenty per cent of BNPL customers missed payments.
Typically, the BNPL provider charges a fee for missed payments. The effect is that a person who misses a payment can start to incur high levels of charges. Some BNPL providers also charge a monthly fee for access to the service. This can be a significant proportion of the payments made if the client only uses Buy Now, Pay Later products for low-cost goods.
Disadvantages to BNPL also include the potential to overspend. If you’re late on payment this incurs fees, and payment defaults can leave a mark on credit history. This means that more vital purchases like a car or home could be at a risk or you may need to pay a higher rate.
How do BNPL companies make money?
The primary source of revenue for Buy Now, Pay Later (BNPL) operators is a fee charged to the merchant (the seller of the goods or services). This can be much higher than the equivalent merchant fee for credit cards (up to 6% as opposed to up to 2%).
Different providers also have charges such as Account Keeping Fees, Establishment Fees, and the Late Payment Fee. Some BNPL operators cap their Late Payment Fees. For the larger BNPL operators, these fees are disclosed to the Australian Finance Industry Association.
What does the surge in cost of living mean for BNPL?
As inflation rises and interest rates go up, BNPL looks more attractive as there is no interest fee to pay. However, the same problems of money management still exist. There is a far greater risk of getting into debt by deciding that food or energy bills should be deferred.
Retailers like Woolworths offer their customers the ability to select PayPal at the checkout and choose the service’s Pay in 4 option. PayPal’s Pay in 4 payment method works similarly to other BNPL services by splitting the total cost of purchase into four separate payments due every two weeks. This represents a real risk of getting into unmanaged debt.
Consumers are likely to turn to BNPL, as they need an alternative credit line. Consumer sentiment of not paying interest on purchase is attractive and there is a tendency for consumers to be overconfident that they can avoid late fees, which is not always the case.
Further, according to the ASIC report, in the 2018–19 financial year, missed payment fee revenue for all BNPL providers totalled over $A43m, a growth of 38% compared to the previous financial year. This clearly illustrates that more and more customers fall into the trap of being overconfident that they can pay on time – but the statistics tell you otherwise.
Another reason? No credit check. This is not necessary with all BNPL service providers, which is another reason that consumers are likely to turn to BNPL with the cost of living crisis.
What rising interest rates and regulation mean for BNPL
The current Reserve Bank of Australia (RBA) policy is to increase interest rates in order to control inflation and bring it back into the target two to three per cent range. The effect of this is to increase interest rates on mortgages and most other forms of credit.
It would not be consistent for the Reserve Bank of Australia to be looking to control inflation and have the ‘interest rate pain’ being deferred using BNPL. The RBA takes the view that there are enough savings to mean that controlling inflation will not lead to a recession.
BNPL does not fit well into this approach. It means there is a high likelihood of further regulatory intervention. There is also an issue for BNPL operators that the BNPL model was based on very low interest rates. The merchant fees and consumer charges were all designed in that low interest rate environment. So, it is likely that BNPL operators will need to consider whether their existing model will work in an environment of higher interest rates.
There is an ongoing debate on whether BNPL should be regulated under credit laws, and whether there is enough consumer protection for those using BNPL and other innovative financial products that are on the market. Let me put this into a perspective.
The majority of BNPL users are millennials who use BNPL as a source of short-term funding. Eighteen to thirty-four year-olds comprise 61 per cent of BNPL users, with 18–24 year-olds making up 23 per cent overall. According to Household, Income and Labour Dynamics in Australia (HILDA) survey, those aged 15-24 years have the lowest financial literacy rate.
This fuels the debate on whether there is adequate consumer protection in the BNPL space, especially for young people and the financially vulnerable. To increase consumer protection around financial innovations like BNPL, there needs to be an increased financial literacy rate.
Education is key to consumer protection – something which is in line with the National Strategy Financial Capability 2022. This is true for vulnerable groups like young Australians, women, people in or nearing retirement, and Aboriginal and Torres Strait Islander peoples.
What does rising cost of living mean for personal debt?
Rising cost of living means more potential to accumulate debt. To keep up with rising prices one needs to either increase income or find an alternative funding source, that is, accumulate debt. Although the current unemployment in Australia is at the lowest rate in decades, real wages and salaries are not keeping up with the inflation. This means households need to find an alternative funding source to manage the gap using a debt arrangement such as BNPL.
The 2020 ASIC report suggested that 43% of users with a BNPL arrangement have taken out additional loans to meet their BNPL obligations. This will be the likely trend going forward to keep up with debt payments which means a snowball effect in the personal debt space.
What should you know before taking on BNPL debt?
Remember the following things before you sign up to BNPL:
- It’s easy to overspend. You can over-commit to spending what you can’t afford.
- Fees add up. You are charged to use the service. Know the fees involved.
- BNPL can be hard to manage. If you sign up for more than one BNPL service, it can be hard to keep track of payments.
- BNPL might affect a loan application. Lenders consider Buy Now, Pay Later spending when you apply for a car loan or mortgage.
- Late repayments can appear on your credit report. This affects your ability to borrow money in the future.
Dr Natalie Oh and Rob Nicholls work at UNSW Business School.