How ‘Buy Now, Pay Later’ Makes Billions From ‘Free’ Loans | WSJ The Economics Of

This burrito bowl dinner on DoorDash comes to $41, but thanks to Klarna, you can make four payments of $10.40 over the course of six weeks instead. The Buy Now Pay Later industry, or BNPL, has exploded as an alternative to credit cards. We really believe the credit card industry is going the way of the VHS tape. But will BNPL actually dethrone credit cards, or will they ultimately just be treated like credit cards? This is the economics of Buy Now Pay Later. Three companies make up the bulk of the BNPL market in the U.S., though two initially found success internationally. Afterpay co-founder Nick Molnar launched the company in Australia in 2014 to entice more people to make purchases at his jewelry store. We built it, we tested it, and it became a very significant portion of our sales really quickly. All of the top providers offer the typical pay-in-four, zero-interest installment loan that has become synonymous with BNPL. Take that burrito bowl. Once the customer chooses the BNPL option at checkout, the provider approves the loan based on its underwriting model. We pay the retailer the next day, and then we take all of the non-payment risk. Then the customer is put on a four-part repayment plan with no interest. If a payment is late, some providers charge a fee. Providers also charge the merchants to make the loans available to their customers. Sometimes that's as much as, you know, five percent of the transaction value. The lion's share of our income, 90 plus percent of our income, is made from the merchant, not the consumer. Some lenders, like Affirm, have also begun to offer longer-term loans that carry interest. About 20% of our business today is zero percent, and about 80% has interest on them. Afterpay also has a pay-monthly option for larger ticket transactions. Customers pay once a month for a longer period of time instead of every few weeks. There's a simple interest attached to these loans. We're not doing it on every checkout flow. We're really doing it on a select few that we believe there's, you know, really strong demand for that particular checkout that's occurring, where paying for might not have the same amount of acceptance. Physical cards that can't be used in a brick-and-mortar store are the next big offering from lenders. That could more or less double the, you know, the potential market. Let's say you're walking into the store and you ask us to spend $500 on a jacket, then we approve the loan. And then it's just sitting out there waiting for you to actually transact. And then at the checkout, the store, you chip your card, and then we pull that transaction that's waiting out there and attach it to the transaction and put a loan into your account. As the scope of buy-now-pay-later expanded, the industry's growth has exploded in the U.S. Buy-now-pay-later transaction volume has multiplied 20 times since 2019. You have a clear macro trend around consumers choosing alternative ways to pay. And that's led to growing competition for both customers and merchants. In March, Klarna announced an exclusive deal with Walmart to provide loans to customers through the retailer's fintech arm, OnePay. It's extremely important for the BNPL providers, particularly the specialist BNPL providers, to have those direct relationships with the merchants. There's a lot of upground out there and a lot of transactions that there's currently nobody being offered. And so I think there's a lot more white space than there is fighting over existing merchants. The types of merchants that have adopted BNPL have expanded, and that's changed what people buy with their loans. BNPL definitely started with e-commerce retail, generally in that ticket size of $100 to $200. As it broadened out, you saw even smaller ticket sizes and sometimes even consumable purchases. A LendingTree survey found that a quarter of BNPL customers have used them to buy groceries, up from 14% in 2024. We don't think it's our job to judge what a consumer's choice is on a financial product that they want to use. Anytime a consumer is putting down their credit card and using a firm, we think it's a good thing. I think the BNPL provider's got to think about that, you know, as to whether is that an indicator that that specific consumer is experiencing more stress or not. In January, the Consumer Financial Protection Bureau released a study that said that more than two-thirds of BNPL loans went to borrowers with lower credit scores. Buy-now-pay-later can make products look a lot more affordable than they actually are. BNPL providers argue that most of their customers are creditworthy. AFPA actually over-indexes in the middle and upper income bracket. You're seeing like really, really strong consumers using the product. But experts say fast growth isn't just risky for consumers. Whenever you look at consumer credit, that next customer is always going to be a little more risky than the customers you've got on your books. And for some providers, consumer losses are growing. In May, Klarna reported a 17% increase in consumer credit losses from the year before. Klarna said in a statement that the rise in losses was because it had issued significantly more loans in Q1 of 25, so it's natural for the dollar value of credit losses to rise. The company added that in Q2, it reported a record share of transactions repaid on time or early. But broadly, LendingTree found that 41% of BNPL users paid late in the past year, up from 34% a year before. Affirm has reported a decrease in customer defaults. We're delivering really good credit outcomes with our approach, which is to underwrite every transaction and to make an honest assessment at the point of sale. And Afterpay says it has seen strong repayment numbers, especially compared to credit cards. We disable someone's account the moment they're late on one installment payment. Our order values are smaller. We're not issuing someone with a few thousand dollar line of credit over an extended period of time. But regulators and other experts have drawn similarities between BNPL and credit cards. In 2024, the CFPB issued an interpretive rule that would subject BNPL providers to credit card regulations. President Trump and Doge have since crippled the Consumer Protection Agency, which announced it would not prioritize enforcing that rule. That's really a concern to those of us who would like to see these technologies used effectively to give consumers more choices in digital finance. There's been shifts within the industry too. FICO announced in June that it would add Buy Now Pay Later loans to credit reports. That's after Affirm became the first major provider to share consumer data with credit bureaus and TransUnion. But Klarna and Afterpay say they're withholding customer data until they're assured its customers won't be unfairly penalized. Klarna said in a statement that it welcomes FICO's ambition to modernize credit scoring to better reflect BNPL use. It also said that it looks forward to a system where these products can contribute positively to consumers' credit standing. And Block, which owns Afterpay, said that the credit reporting scoring and interpretation still largely operate under legacy frameworks. So the company argues that there needs to be a separate framework for BNPL and credit cards. A regulatory framework that respects those components of the product and builds the framework around something that is very different to traditional forms of credit is one that we've been really hard at work on from the day we started the business. I don't think that BNPL will replace credit cards. I think it's going to replace credit cards for certain people and may replace credit cards for many people for certain types of transactions. Even if BNPL providers would prefer credit cards disappeared, nothing would make our team happier than if we could see the death of revolving credit in the United States.