Buy now, pay later is booming, but concerns remain around merchant fees, credit risk, and the benefit to the consumer

• Buy now, pay later is booming, as big payments players like Square, PayPal, and Apple Pay wade in.
• Now, regulators and consumers are considering the pros and cons of BNPL.
• From merchant fees to credit risk, these are the top concerns of the growing industry.

Buy now, pay later — the point-of-sale financing feature popularized by fintechs like Affirm, Afterpay, and Klarna — is the fastest growing area in payments. But experts see growing pains ahead for the red-hot market.

Valuations have soared among BNPL players. Klarna is Europe’s most valuable private company, worth $46 billion. Square announced plans to buy Afterpay for $29 billion, and Affirm, though its stock is trading well below its IPO-day pop, has a market cap of roughly $17 billion.

“From an investor point of view, we’ve seen more interest than ever,” Ben Savage, partner at Clocktower Ventures, which has previously invested in white-label BNPL fintech Bread, told Insider.

Incumbents are stepping in, too. Alliance Data Services, a leader in the co-branded credit card space, acquired white-label BNPL player Bread. Barclays co-brand business has a partnership with BNPL infrastructure provider Amount. Apple is reportedly working with Goldman Sachs to roll out an installment product on Apple Pay.

But it’s not just competition that’s rocking the BNPL world. The fintechs’ business models, which rely on higher merchant fees than typical credit-card transactions, are coming under pressure. And consumers are starting to question whether BNPL is the smartest way to spend on discretionary purchases.

“Is it good for consumers? Are people worried about that? Sure, we are very worried about it. Other VCs, depending on how much they pay attention to this, can be worried about it,” Savage said.

From questions around the benefits and risks of BNPL to an eventual standoff with merchants over fees, here are the biggest looming threats to buy now, pay later.

The pros and cons of BNPL are up for debate

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Like any other type of credit, BNPL offers consumers flexibility and can help people afford items they may not otherwise be able to by splitting payments over a longer period than a monthly credit-card statement.

BNPL players boast their ease of use. And less friction in the purchasing process means consumers are likely to spend more.

“You could construe that as a good thing or you could construe that as a bad thing, depending on the way you’re looking at it,” Savage said.

Used wisely, BNPL could be the more prudent decision for a shopper, especially if it means avoiding interest on unpaid credit-card bills.

While Afterpay and Klarna charge late fees, they don’t charge interest. Affirm, on the other hand, issues interest-bearing loans (though some of its loans are 0% APR, depending on the merchant), but does not charge any late fees.

PayPal announced Wednesday it will eliminate late fees on its pay-in-four product globally beginning October 1.

However, as is the case with any credit product, there is the risk of overspending. And it can be easy to lose track of several BNPL balances if a consumer is using multiple providers at different retailers.

“What we’re seeing actually in the data is that very quickly, you can end up in a situation where it’s easy to overspend because you lose track of all of the things you’re actually buying,” Colleen McCreary, chief people, places, and publicity officer at Credit Karma, told Insider.

BNPL is typically easier to access than a new credit card because there aren’t hard credit checks, Laura Udis, small dollar, marketplace, and installment lending program manager at the Consumer Financial Protection Bureau told Insider.

Afterpay makes credit decisions based on a users’ history with Afterpay itself. Affirm boasts more than 200 data points to evaluate risk. But applying for a BNPL product won’t ding your credit report.

And most BNPL providers don’t report ongoing loan performance to credit bureaus. Some analysts have warned that the opacity of BNPL credit reporting could mask a consumer’s total debt. Late payments, however, often impact credit, especially if the unpaid balances go to collections.

“It’s not being reported when you’re doing all the right things,” McCreary said, referring to a customer making payments on time. “There’s no credit for good behavior.”

In the UK, some consumers have said that having BNPL payments on their bank statements were taken into account when applying for mortgages, according to Refinery29.

Atypical data due to COVID-19 complicates the story

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BNPL took off during the coronavirus pandemic, which impacted consumers in myriad ways. And that’s a crucial lens to apply when looking at BNPL performance data, McCreary said.

Where the data is available, performance of BNPL portfolios has been relatively good. Affirm’s delinquency rates hovered between 1% and 2% in 2020, according to its most recent earnings. While Afterpay doesn’t report delinquencies, it does disclose that late fees currently make up less than 9% of its total income, down from 15% in 2019, according to its most recent half-year report.

Klarna does not disclose late-fee figures, but a spokesperson told Insider that they’re “very low,” and Klarna has controls in place where consumers can’t keep using the service if they have an unpaid balance.

It’s those delinquencies and late fee figures, as well as consumer complaints, that regulators like the CFPB are watching, Udis said.

But data on consumers’ credit performance since the onset of the pandemic is complicated. Most lenders tightened underwriting last year. And while many consumers relied on government subsidies to pay their bills, others had more money in their pockets and were saving at record rates.

“I think the data is really blended, and as the economy continues to go through this up-and-down relative to COVID, there will probably be more people on the lower end who will shake out,” McCreary said.

Merchants will ultimately decide whether BNPL sticks

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Merchant fees are key to Affirm, Afterpay, and Klarna’s business models. Whereas a typical credit-card transaction costs merchants between 1% and 3%, BNPL fees range from 3% to 7% of the transactions.

But incumbents are coming in with low or no-cost BNPL products, baking them into their existing relationships with merchants. PayPal launched its pay-in-four product at no additional cost to retailers. And Barclays previously told Insider that it plans to price BNPL offerings, via its partnership with Amount, into its existing deals with co-brand retail partners.

Affirm, Afterpay, and Klarna justify their rates by boosting average order values and converting browsers to buyers. Merchants, facing uncertainty in the early months of the coronavirus pandemic, were keen to add these services as a way to keep selling.

But now, merchants are more bullish on consumer spend, which means the power dynamics may shift. BNPL players are also pushing to build awareness among consumers, fighting for consumer loyalty with rewards programs and debit cards of their own that could be viewed as a threat to merchants.

“What’s really challenging about buy now, pay later is the ultimate economics of it,” Savage said. “I think it’s really the merchants that will ultimately decide whether buy now, pay later sticks around, because they pay so much more for buy now, pay later than they do even to process very expensive credit cards.”

As BNPL becomes a more common way to pay, merchants’ costs will rise. There are two ways to offset that: higher prices or lower fees.

But raising prices is a risky move for a retailer, especially to subsidize the cost of BNPL, which currently only accounts for 2% of total payments in the US, according to FIS.

“Something has to give in the economics,” Savage said. “Either merchants raise prices, or the fees come down and the profitability of the business declines.”