Looking to spread out the cost of a pricier-than-expected holiday gift for a friend, family member or yourself?

A slew of new app-based financing options are ready to help you make that happen.

But while the emerging buy now, pay later options are really just digital re-workings of once ubiquitous retail layaway plans, it’s a payment choice that can lead to harsh consequences for the unwary.

Buy now, pay later companies like Affirm, Afterpay, Klarna, Sezzle, Zip and others are finding success in partnering with retailers to offer portals for issuing credit at time of purchase that allows the consumer to check out, virtually or in person, with their goodies after agreeing to an installment plan. Some charge interest, some don’t, and rescheduling a payment or paying late can also come with charges.

The most significant potential consequence may be how easy buy now, pay later plans make it to financially overextend via what is essentially a loan application process that takes only moments to complete.

Buy now, pay later providers have carved out a consumer financing niche, using real-time “soft” credit inquiries that don’t pull up credit scores, don’t appear on the applicant’s credit report and, should credit be issued, doesn’t report new debt obligations back to credit agencies. This opens the door for applicants who may not qualify based on their scores, want to avoid maxing out current credit cards or who simply don’t have ample credit history to pass a more in-depth credit assessment.

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No-fees, sort of 

For many of the new buy now, pay later providers, their no-interest or no-fee marketing promises hold up, but only as long as you adhere to the contract-stipulated installment plan.

If you miss a payment, many of the apps have late fees that kick in while others apply interest rates reaching as high as 30%, per a report released earlier this year by U.S. PIRG. Missing payments may cause buy now, pay later debt to be turned over to debt collectors, or end up as dings on a consumer’s credit report. These repercussions are not uncommon in the buy now, pay later world; more than 7 out of 10 customers have faced late fees or interest rate charges. According to one study, 72% of those who had fallen behind on payments saw their credit score fall as a result.

Deferring payment is cool again

One of the biggest economic challenges facing the Federal Reserve in its year-long battle against record U.S. inflation has been the resilience of consumer spending. Shoppers flush with stimulus cash and stymied in their desires to spend money on services amid COVID-19 restrictions saved money, paid down debt and stashed their credit cards. But as the world reemerged from home isolation, spending came back in a big way, including whipping out the plastic.

Earlier this month, the New York Federal Reserve reported that U.S. consumer debt rose by $351 billion in the third quarter of the year, reaching $16.51 trillion. Mortgage balances — the largest component of household debt — climbed by $282 billion and stood at $11.67 trillion at the end of September. And credit card balances rose by $38 billion over the second quarter of 2022 and are now 15% higher than the same time last year, marking the highest year-over-year increase in more than 20 years, according to the report.

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In a November analysis of retail spending data and the New York Fed report, Wells Fargo economists Tim Quinlan and Shannon Seery noted the jump in consumer debt represented the largest annual increase since the Great Recession and could be a foreshadowing of future peril, should consumers over-leverage their spending by continuing to accumulate new debt.

“Even with continued consumer resilience, some cracks are slowly forming in the foundation,” Quinlan and Seery wrote. “Households have increasingly relied on credit to spend and increased overall debt $351 billion in the third quarter, putting the total debt burden for households at $16.5 trillion, according to data released by the New York Federal Reserve. That’s an increase of 8.3% from a year earlier, the biggest annual increase since a 9.1% jump in Q1-2008 at the start of the 2008-2009 recession.

“Near-term consumer resilience will come at a further deterioration in household finances as households draw down savings and accumulate debt to spend. That may eventually spell economic trouble.”

The money trap

Earlier this week, the Washington Post editorial board shared its concerns about where buy now, pay later financing is headed, noting the industry is largely unregulated and substantial issues have emerged. Besides the trap of late fees, the Post writes that users are complaining that it is difficult to get refunds and issues can ding their credit score in ways they didn’t realize. But the biggest concerns, per the Post, are that many of these financial technology companies are not doing a sufficient job assessing people’s ability to repay and are using shoppers’ data to suggest more products to buy — on credit.

Credit reporting company TransUnion found that buy now, pay later borrowers are using the product just as much as credit cards, piling debt on top of additional debt, according to the Associated Press. A poll by Morning Consult released in September found 15% of buy now, pay later customers are using the service for routine purchases, such as groceries and gas, a type of behavior that sounds alarm bells among financial advisors, per AP.

The watchdogs are watching

In September, the Consumer Financial Protection Bureau issued a report offering insights on the buy now, pay later industry.

While the industry grew rapidly during the pandemic, bureau analysts noted borrowers may receive uneven disclosures and protections. The five firms surveyed in the report originated 180 million loans totaling over $24 billion in 2021, a near tenfold increase from 2019.

“Buy Now, Pay Later is a rapidly growing type of loan that serves as a close substitute for credit cards,” said Consumer Financial Protection Bureau Director Rohit Chopra in the report. “We will be working to ensure that borrowers have similar protections, regardless of whether they use a credit card or a Buy Now, Pay Later loan.”

According to findings in the report, the marketing of buy now, pay later loans can make them appear to be a zero-risk credit option, but today’s report identified several areas of risk of consumer harm, including:

  • Inconsistent consumer protections
  • Data harvesting and monetization
  • Debt accumulation and overextension

To address the discrete consumer harms, the Consumer Financial Protection Bureau said it will identify potential interpretive guidance or rules to issue with the goal of ensuring that buy now, pay later lenders adhere to many of the baseline protections that Congress has already established for credit cards. As part of this review, the agency said it will also ensure buy now, pay later lenders, just like credit card companies, are subjected to appropriate supervisory examinations.