Americans may be taking on ‘Phantom Debt’ too much later

“Buy now, pay later” loans are helping fuel a record holiday shopping season. Economists worry they could also mask and exacerbate the cracks in Americans’ financial well-being.

The loans, which allow consumers to pay for purchases in installments, often interest-free, have skyrocketed in popularity due to high prices and interest rates. Retailers have used them to attract customers and get people to spend more.

But consumer groups and some lawmakers say such loans could push younger and lower-income Americans to take on too much debt. And because such loans are not routinely reported to credit bureaus or recorded in public records, they can also pose a hidden source of risk to the financial system.

“The more I look into it, the more concerned I get,” said Tim Quinlan, a Wells Fargo economist who recently published a report describing delinquent loans as “phantom debt.”

Traditional measures of consumer credit indicate that U.S. household finances are relatively healthy overall. But, Mr Quinlan said, “if these companies are missing out on the fastest growing part of the market, then those reassurances won’t be worth a cent.”

Estimates about the size of this market vary widely. Mr Quinlan believes spending through pay-later options was about $46 billion this year. That’s relatively small compared to the more than $3 trillion Americans put on their credit cards last year.

But such loans – offered by companies like Klarna, Affirm, Afterpay and PayPal – have risen rapidly. This growth comes at a time when some Americans’ finances are starting to show early signs of strain.

Credit card borrowing is at a record high in dollar terms – but not as a percentage of income – and delinquencies, while low by historical standards, are on the rise. This stress is especially visible among younger adults.

According to the Federal Reserve Bank of New York, people in their 20s and 30s are by far the biggest users of payday loans. That could be both a sign of financial trouble – young people may turn to payday loans after maxing out their credit cards – and a cause of it by encouraging them to spend excessively.

Liz Cisneros, a 23-year-old student in Chicago who works part-time at Home Depot, said she was surprised by the convenience of post-payment programs. During the pandemic, she saw influencers on TikTok promoting the loans and a friend said it helped her buy designer shoes.

Ms. Cisneros started using it to buy clothes, shoes and beauty products from Sephora. She often had multiple loans at the same time. She realized she was spending too much money when she didn’t have enough money at the supermarket checkout. A later paying company had taken money from her bank account that morning and she had lost her payment schedule.

“It’s easy when you keep clicking and clicking and clicking, and then it doesn’t happen anymore,” she said, referring to the moment she realizes she’s spent too much.

Ms Cisneros said the problem was particularly bad around Christmas, and she skipped holiday shopping this year so she could pay off her debts.

Pay-later loans became available in the United States years ago, but took off during the pandemic, when online shopping boomed.

The products are somewhat similar to the layaway programs offered by retailers decades earlier. Online shoppers can choose from pay later options at checkout or in the apps of pay later companies. The loans are also available at some brick-and-mortar stores; Affirm said Tuesday that it had begun offering payday loans at Walmart stores’ self-checkout counters.

The most common loans require buyers to pay a quarter of the purchase price up front, with the remainder usually paid in three installments over six weeks. Such loans are usually interest-free, although users may sometimes be charged fees. Pay-later companies make most of their money by charging fees to retailers.

Some lenders also offer interest-bearing loans with repayment terms that can last from several months to more than a year.

Pay-later companies say their products are better for borrowers than credit cards or payday loans. They say that by offering shorter loans, they can better assess borrowers’ ability to repay.

“We are able to identify and extend credit to consumers who have the ability and willingness to repay more than they would on revolving credit accounts,” Affirm Chief Financial Officer Michael Linford said in an interview.

In the most recent quarter, 2.4 percent of Affirm loans were 30 days or more delinquent, up from 2.7 percent a year earlier. These figures do not include loans with four installments.

The service makes the most sense for certain purchases, such as buying an expensive sweater that will last for many years, Klarna CEO Sebastian Siemiatkowski said.

He said paying later probably makes less sense for more frequent purchases such as groceries, although Klarna and other companies do make their loans available at some supermarkets.

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Mr. Siemiatkowski acknowledged that people could misuse his company’s loans.

“It’s obviously still an honor and so you’re going to find a subset of individuals who unfortunately use it in a way that wasn’t intended,” said Mr. Siemiatkowski, who founded Klarna in 2005. He said the company tried to identify those users and deny them loans or impose stricter conditions on them.

Stockholm-based Klarna says its global default rate is less than 1 percent. In the United States, more than a third of customers pay off loans early.

Kelsey Greco made her first pay-later purchase about four years ago to buy a mattress. It would have been difficult to pay $1,200 in cash, and it seemed unwise to put the purchase on a credit card. That’s why she got a twelve-month interest-free loan from Affirm.

Since then, Ms. Greco, 30, has used Affirm regularly, including for a Dyson hair tool and car brakes. Some loans charged interest, but she said she preferred this form of borrowing even then because it was clear how much she would pay and when.

“With a credit card, you can swipe it all day and say, ‘Wait, what did I just get myself into?’” said Ms. Greco, a Denver resident. “Whereas with Affirm you get clear numbers where you can see, ‘Okay, this makes sense,’ or this doesn’t make sense.”

Ms. Greco, who was introduced to The Times by Affirm, said payback loans helped her avoid credit card debt, which she had previously had trouble with.

But not all consumers carefully use the options to pay later. a report from the Consumer Finance Protection Bureau This year it found that almost 43 percent of post-paying users had overdrawn a bank account in the past twelve months, compared to 17 percent of non-users.

“This is just a more vulnerable part of the population,” says Ed deHaan, a researcher at Stanford University.

In a paper published Last year, Mr. DeHaan and three other scientists found that within a month of first using late-payment loans, people became more likely to overdraw and start falling behind on their credit card payments.

Financial advisors who work with low-income Americans say more and more clients are turning to payday loans.

Barbara L. Martinez, a financial advisor in Chicago who works at the nonprofit Heartland Alliance, said many of her clients used cash advances to cover late-payment loans. When the paychecks come in, they don’t have enough to pay the bills, forcing them to make more late payments.

“It’s not that the product is bad,” she added, but “it can get out of hand very quickly and cause a lot of damage that could have been prevented.”

Briana Gordley learned about pay-later products in college. She was working part-time and couldn’t get approved for a credit card, but late-payment providers were eager to extend her credit. She started to fall behind when her work hours were cut back. Eventually, family and friends helped her repay the debts.

Mrs. Gordley, who testified about her experiences last year at a listening session hosted by the Senate, now works on consumer finance issues for Texas Appleseed, a progressive policy organization. She said post-payment loans can be an important source of credit for communities that don’t have access to traditional loans. She still uses them occasionally for larger purchases.

But she said companies and regulators must ensure borrowers can pay the debt they take on. “If we’re going to make these products and build out these systems for people, we also have to have some checks and balances.”

The Truth in Lending Act of 1968 requires credit card companies and other lenders to disclose interest rates and fees and provides borrowers with several protections, including the ability to dispute charges. But the law only applies to loans with more than four payment terms, effectively eliminating many late payments.

Many such loans are also not reported to credit bureaus. This allowed consumers to take out multiple loans from Klarna, Afterpay and Affirm without the companies being aware of the other debts.

“It’s a huge blind spot right now, and we all know it,” said Liz Pagel, a senior vice president at TransUnion, who oversees the company’s consumer lending business.

TransUnion, other major credit bureaus and late payment companies all say they support more reporting.

But there are practical obstacles. The credit rating system rates borrowers higher for having longer-term loans, including long-standing credit card accounts. Each purchase with post-payment qualifies as a separate loan. As a result, these loans could lower borrowers’ scores even if they pay them back in full and on time.

Ms Pagel said TransUnion had set up a new reporting system for the loans. Other credit bureaus, such as Experian and Equifax, do the same.

Pay-later companies say they report certain loans, especially those with longer terms. But most do not report and will not commit to reporting loans with only four payments.

That worries economists, who say they are particularly concerned about the impact of such loans as the economy weakens and workers start losing their jobs.

Marco di Maggio, a Harvard Business School professor who has studied pay-later products, said that in tough times, more people would use such loans for smaller expenses and get into trouble. “All it takes is one more shock to force people to default.”