The New York Federal Reserve receives detailed quarterly reports from the major credit bureaus, allowing it to monitor the state of U.S. credit card debt. Though many Americans are increasingly using buy now, pay later services in lieu of credit cards, BNPL companies are not currently required to report data on their loans.
Around 25% of U.S. consumers used BNPL in the past year, a number that is expected to rise. With both fintech startups and established banks frequently rolling out new “Pay by X” plans, there are growing concerns about the immense and unknown amount of “phantom debt” that is starting to snowball.
According to some experts, that snowball could turn into a delinquency avalanche, potentially adversely affecting the U.S. economy.
“I think the notion of there being a “phantom debt” crisis is legitimate, if a bit overblown,” said Ben Danner, Senior Credit and Commercial Analyst at Javelin Strategy & Research. “We know that BNPL customers tend to be from higher risk segments and data from the Consumer Financial Protection Bureau (CFPB) shows BNPL borrowers tend to be more stressed financially.”
Modern-Day Layaway
The two segments that have adopted BNPL most rapidly are Gen Z and parents of young children, according to a recent report from Nerdwallet. Roughly 40% of Gen Z consumers and 37% of parents used BNPL in the last year. These demographics are also more likely to struggle with loan repayment.
BNPL has often been considered a modern-day layaway, where consumers split big-ticket purchases into smaller installments. However, the report found that 8% of Americans have used buy now, pay later services to pay for everyday items like groceries, raising concerns among experts.
“Around 18% of BNPL borrowers had at least one delinquency in another account, which means they may be some of the first consumers to go delinquent if the economy sours,” Danner said. “However, it’s important to mention that the average BNPL ticket size of $150 is much smaller than the $6,500 average credit card balance. BNPL vendors also have their own guard rails to limit the amount of debt a consumer can take on.”
Credit Card Alternatives
Those limits, coupled with no interest or annual fees, are reasons BNPL lenders have touted their products as superior alternatives to credit cards. However, there is a trade-off, as buy now, pay later customers miss the rewards that credit cards often provide. BNPL services also charge late fees like credit cards.
These products are easier to obtain, since BNPL companies often only do a soft credit check. In contrast, credit card companies conduct hard credit checks and report delinquencies to credit bureaus like Equifax, Experian, and TransUnion. This data is used to create credit scores, which determine a consumer’s creditworthiness.
Since BNPL companies don’t report their users’ loan details and payment history, outstanding loans aren’t considered in credit scores. Initial attempts to factor in BNPL loans have resulted in negatively skewed scores.
That’s one of the reasons the CFPB issued an interpretive rule stating BNPL companies have to conform to the same standards as credit card companies. This means they will have to send monthly billing statements like credit card companies, fully disclose any fees, and handle disputes in the same manner.
Once these changes take effect, BNPL products might not look so different from credit cards after all.
“We are now seeing (BNPL) lenders launch new products in the U.S. market that seem at odds with their initial brand—physical cards,” Danner said. “Both Affirm and Klarna have launched card products to try to attract consumers into their payment ecosystem and to use them for in-store purchases. In many ways these products are attractive for higher volume, small ticket items such as everyday spend items. BNPL has grown to be more than just a financing tool for one-time large purchases.”
Fueling the Mystery
The nascent industry’s rapid growth has fueled the mystery surrounding it. Along with established players like Klarna, Affirm, and Block-owned Afterpay, more startups like Zilch are entering the market.
It’s telling, however, that Apple just moved away from its in-house BNPL service, Apple Pay Later. The tech giant abandoned buy now, pay later in part due to heavy competition. Apple will now offer these services through Affirm and other providers.
All the movement in the industry has created uncertainty, but according to Affirm, any “phantom debt” concerns are unfounded. The company estimated that outstanding debt from these transactions was 0.3% of the $1.1 trillion in credit card balances in 2023 and said delinquencies were extremely rare.
Though this type of debt might not pose an economy-crippling threat, the BNPL sector will continue to draw attention from regulators.
“There is an important lack of visibility when it comes to credit scoring as many of the BNPL products on the market are not reporting to the bureaus,” Danner said. “It can lead to issues such as loan stacking, which has been a hot button topic for regulators. I expect more policy decisions to come, likely using prior regulations from credit card lending, to rein in BNPL.”
