As buy now, pay later services have grown more popular, there remains virtually no oversight

Back when Briana Gordley was a full-time college student, working at a part-time internship making about $15,000 a year, she took a rare trip to the mall and wandered into Forever 21. One of the employees told her that the company had just started partnering with a service called Afterpay, which would allow Gordley to buy clothes without paying the full cost up-front, instead paying it off in four installments. It was the first time she’d ever heard of buy now, pay later products that allow consumers to pay a fraction of the total cost up-front and then make the rest in four installments, typically over eight weeks.

“I thought, ‘Oh my gosh, that’s so manageable,’” she said. Her income didn’t allow her to buy a lot of clothes or big items like furniture without saving up. “As a college student, it was so attractive to me. I felt like I could afford things that everyone else was getting,” she said.

She signed up for the Afterpay app on the spot. Given her low income, she wasn’t even sure she’d be approved. But she quickly was. There was a blurb in the paperwork saying there would be small fees for not making payments on time, but she figured she could handle it. “I already went through this process of signing up, I don’t care if there are going to be fees,” she recalled thinking. “I’m sure it won’t be that big of a deal.”

“A lot of it was being excited to have this opportunity to get the products I couldn’t get before,” she said. “Being able to afford it, in the grand scheme of things, was not my concern.”

Buy now, pay later options have proliferated during the pandemic as consumers moved their purchases online. Now, at checkouts from Chipotle to Target, consumers are given the option of paying just a slice of the cost up-front and making the rest in installments. Unlike credit cards, signing up doesn’t involve a hard credit check, and the payments don’t accrue interest. As of January 2022, about one in five Americans had used a buy now, pay later service. The fact that they don’t typically come with interest may sound like a good deal, but there are financial pitfalls, many of which may not be clear when a consumer first signs up.

Even as these products have grown in popularity and ubiquity, there’s virtually no regulatory oversight. Although the Consumer Financial Protection Bureau has started investigating the issue, it’s unclear what it will decide to do or how long that will take. In the meantime, consumers go without many protections and run the risk of fees piling up.

“I said, ‘Okay, why not?’”

After Gordley signed up with Afterpay, she was given a line of credit, and then the app started showing her clothes from stores she never would have shopped at before. “I said, ‘Okay, why not?’” she said. She started racking up purchases made with the buy now, pay later app, as many as five or six at a time, each above the $30 minimum and sometimes for as much as $100. When she hit her max at Afterpay, she applied at Klarna thinking perhaps she wouldn’t get approved. She was—and she was given a limit of $1,500.

At first she didn’t worry about when the automatic payments for the installments would come out of her bank account, because she figured they would line up with the paycheck she got every two weeks. But each payment period had its own schedule based on different purchase dates. They started hitting when she didn’t have enough money in her bank account, so she started racking up overdraft fees, each at $29 a pop. When she delinked her bank account from the apps she got hit by late fees, which started out small—$2 or $3—but compounded, quickly rising to $10 or $11. She estimates the late fees eventually cost her $250 to $300.

In response to a request for comment, an Afterpay spokesperson said, “We are not a loan and don’t allow consumers to follow into revolving debt (if you miss one payment, you can’t use the platform until that payment is made).” A Klarna spokesperson said it has “clear repayment plans that are easy to track,” and added that the company restricts the use of its services if any payments are missed.

“Consumers have varying understandings of these products, whether they view them as credit, whether they view them as having the same implications as other debt that you owe, whether they truly understand the associated costs,” said Rachel Gittleman, financial services outreach manager at the Consumer Federation of America, an industry watchdog. “This could be a helpful tool for some consumers, [but] overall the incentive is to have consumers take on unmanageable amounts of debt.”

The smaller up-front cost may make purchases look more affordable, but “just because the price is cut into four doesn’t mean it really is,” noted Lauren Saunders, associate director at the nonprofit National Consumer Law Center. And then consumers usually have just six weeks to pay the rest off. “It’s a pretty short period of time. That’s really one rent cycle,” she noted. In a recent survey, 45% of buy now, pay later users said they used the option to buy things they otherwise couldn’t afford. “If you can’t afford it today, can you really afford it in six weeks?” she asked.

Another pitfall consumers face is that the repayment schedule for each buy now, pay later purchase starts on the date it was made, which means the payments for multiple purchases will be due at different times. That makes them hard to keep track of. Over half of users say they’ve been paying off more than one buy now, pay later purchase at the same time. If consumers attach their bank accounts for automatic payments, they risk paying overdraft fees if they can’t ensure that there’s always enough money at the right time; if not, they risk incurring late fees.

Those fees are not always easy to find, and where to find them differs from company to company. “Sometimes it’s in their consumer contract, sometimes in their frequently asked questions,” Gittleman said. Some will mention that fees are possible but not outline how much they can be. “You have to be really searching for it,” she said. The “inability to compare costs among products makes it harder for consumers to make educated guesses.”

And they can be hefty, particularly given the small purchase amounts. Afterpay, for example, charges $8 or 25% of the transaction, whichever is less. Sezzle typically charges $10 for a failed payment and $5 to reschedule two or more payments per order. Zip charges a $7 late fee. Depending on the size of the original purchase, those can amount to “several hundred percent on an APR basis,” Saunders noted.

“With a lot of young customers that are new to financial services, Sezzle strives to become the right training product and ensure users don’t go over their skis,” Sezzle CEO Charlie Youakim said in response to a request for comment. An Affirm spokesperson said, “Affirm is a transparent and flexible option for paying over time,” noting that it doesn’t charge late fees.

Unlike when a consumer applies for a credit card or another kind of loan, buy now, pay later companies are not conducting “meaningful underwriting” of their offerings, Gittleman said, which means they aren’t running full credit checks and assessing whether a consumer will actually be able to pay it back. Most simply verify a consumer’s identity, perhaps looking at whether the consumer has paid back previous buy now, pay later loans. An Affirm spokesperson said it uses “continuously learning models” to assess a consumer’s ability to pay, while Klarna said it assesses “a number of data points,” including a consumer’s history with the app, and Zip looks at “various factors.” For his part, Youakim said Sezzle “does not conduct a traditional credit check” but instead uses other data to determine consumers’ credit limits. But 30% of users say they’ve had to delay or skip paying other essential bills like utilities, rent, or car payments to make a buy now, pay later payment.

“Most people don’t know that this is happening”

Buy now, pay later loans also don’t come with the dispute rights consumers are due when they use credit cards to make purchases. Under those rights, if a merchant bills a consumer for the wrong amount or fails to deliver a product, the consumer can require the credit card company to issue an up-front refund and sort it out with the merchant directly. It’s “a powerful tool,” said Ed Mierzwinski, senior director of the federal consumer program at U.S. PIRG, a consumer protection and environmental nonprofit.

There is no such protection for a purchase made with buy now, pay later loans, and consumers have filed a multitude of complaints with regulators saying they were still required to make the payments even when their purchases failed to show or arrived broken. One person complained to the CFPB that after a glitch in the Afterpay app duplicated an order, they were still charged for the second, false order. Another wrote to the Better Business Bureau saying that after they canceled a purchase made with Klarna after finding out the item was not in stock, the company didn’t issue a refund and the consumer was still being required to make payments. (The Afterpay spokesperson claimed that consumers are protected because they make purchases with their credit and debit cards.)

Buy now, pay later products are attractive to merchants because they appear to prompt consumers to buy more than they otherwise would, increasing margins. They “convince people to buy stuff they don’t need and can’t afford,” Mierzwinski said. That may be why merchants are willing to pay the fees that make up the bulk of buy now, pay later companies’ profits. But some advocates warn that, as the industry becomes more competitive, merchants are likely to push back against the fees, which could prompt the companies to either increase consumer fees or cut down on customer service and protection. “Right now, their business model is clearly to make the bulk of their money from the merchant side of the platform by charging them those high interchange fees,” Mierzwinski said. “The pressure is going to be on the business model to change to make more money on the consumer if merchants say, ‘We don’t want to pay as much money as you’re charging us.’”

These companies are also collecting vast amounts of data on their consumers that they can use to try to prompt them to make more purchases they wouldn’t have otherwise. A credit card company or bank only knows where consumers spend money and how much; merchants know exactly what you bought with them and how often. “The buy now, pay later company gets both sides of the ledger,” Mierzwinski pointed out. It “gets a much more robust set of information that it can monetize.” That allows them to pinpoint their advertising for other merchants and other products to consumers. “Most people don’t know that this is happening,” added Nadine Chabrier, senior policy counsel at the Center for Responsible Lending.

Consumer advocate groups are urging regulators to step in, particularly the Consumer Financial Protection Bureau. “There needs to be oversight, just like there is in every financial product,” Gittleman said. When reached for comment, a spokesperson for the CFPB said, “We can’t comment on whether we intend to regulate BNPL [buy now, pay later] at this time.”

“We just want to make sure people are safe”

Buy now, pay later companies have so far skirted rules in the Truth in Lending Act that apply to installment loans by claiming they fall just under the threshold. Under the act, installment loans are those that require consumers to make five or more payments; because they all use a model of paying in four installments, they fall just outside.

They also claim to be exempt from rules governing credit cards. But consumer advocates argue they should be regulated like credit cards, given that they offer open-ended financing for repeat use and most offer consumers lines of credit. “Buy now, pay later is credit, so it should be regulated like credit,” said Chabrier. That would mean companies would have to disclose fees more prominently and uniformly, charge consumers on the same day every month, resolve merchant disputes the way credit card companies have to, and underwrite the loans doing a credit check and assessing a consumer’s ability to pay.

“They’re making loans, charging late fees,” Mierzwinski argued. “They’re doing a lot of things that make them at least subject to the Consumer Financial Protection Bureau’s regulations.”

His and over 75 other groups recently sent a letter to the CFPB urging it to take action and to treat buy now, pay later loans like credit cards. The CFPB appears to be on the case: In December, it ordered five big players to send it information about their business practices, saying it was concerned with consumers accumulating debt and companies skirting regulations and harvesting consumer data. It also just closed a public comment period on the topic. Then in April, it invoked its authority to examine nonbank companies, including those “whose activities the CFPB has reasonable cause to determine pose risks to consumers.” Mierzwinski said the announcement “is certainly a warning to firms that action is coming to rein in practices that appear designed to evade consumer protection laws.”

California has already taken action, classifying buy now, pay later plans as loans under its consumer protection laws. In late 2019 and early 2020, after the state found Afterpay, Quadpay (now Zip), and Sezzle to have structured their products to evade regulation, the three companies refunded about $1.9 million in fees to consumers. The companies must now consider California consumers’ ability to repay the loans, respond to their complaints, and are now subject to rate and fee caps. But so far California is the only one. (A Zip spokesperson said the company’s “revenue model does not rely on customers falling behind.”)

Gordley was lucky: Her mother, an accountant, stepped in when she found out what was going on and loaned Gordley the money to pay off all of her purchases, putting an end to the cycle.

“At the time I just blamed myself. I thought, ‘Okay, I should have been smarter about what I was getting myself into,’” she said. But Gordley now works as a policy analyst for the nonprofit Texas Appleseed, where she’s realized the problem is much bigger. “These products can become abusive if they’re left unchecked,” she said. “We don’t want to get rid of these products, we just want to make sure people are safe.”