Klarna, Afterpay, Clearpay, Paypal’s “Pay in 3” are all examples of Buy-Now-Pay-Later, or BNPL, systems in which you can postpone payments (up to 30 days), or pay your purchases in installments. For example, if you’re on the Zara website and you’ve just ordered about €500 worth of clothing, you can use Klarna to pay this amount later, or in 3 installments of €166,67. These payment systems have become increasingly popular amongst younger generations and participants of the gig-economy allowing consumption smoothing when income streams may have been irregular or uncertain. In this post we’re going to review these systems which continue to gain traction, and have seen a massive surge in usage during the pandemic.
Nothing New Under the Sun If you really think about it for longer than .5 seconds you’ll realise that these BNPL systems are nothing new. Not only has the credit card been around since the 1960s, catalog ordering has been around for almost equally as long. I suspect most people are aware of the credit card, with their interest free periods which always end too soon and their savings and cashback programs which never really target the things you actually spend money on. Catalog ordering, on the other hand, was the act of actually going through a physical catalog (they were sent per post, especially around the holiday seasons) with all products nicely displayed, with cards in between that could be sent through the mail (the physical mail) with product codes on them, to get the item(s) in question. Payment in this case could also be delayed or done in installments, the latter being the most popular. So no, Afterpay in its many forms is really nothing new.
Benefits Now similar to the credit card and the catalog method there are both benefits and drawbacks. Let’s focus on the benefits first:
Benefit number one is the obvious consumption smoothing aspect to BNPL: you don’t need to have the money now to be able to get the product(s) you want. There’s no waiting involved. Despite your bank account balance saying: “mayhaps not”, thanks to BNPL you can buy things immediately. You don’t have to wait any longer. Immediate gratification is at your beckoning. That doesn’t necessarily mean you can afford it, but more about that later.
A second benefit is that the delayed payment or the installments are interest free. You are essentially borrowing money, but unlike most loans and most credit cards (after the interest free period) there’s no charge on the money being lent to you. So that’s nice!
And third, and to me it’s most useful benefit: there’s a lot less administrative mess when doing returns. I order clothes online quite a bit, and often getting the right size remains an issue. So what do you do? You order multiple sizes and return the ones you don’t end up needing. Had you already paid the amount in full, you’re now waiting for that money to be returned to you, despite knowing that the amount you had paid would be much higher than the amount of money you’d actually end up spending. Now, with the BNPL systems, you do actually only end up paying for the products you wanted to keep. The return of both the products you don’t want and the money you no longer owe as a result of that all happens automatically at their back end, and not yours. Nice!
Cons Now it wouldn’t be an article on Money on the Mind if we didn’t critically review what was going on here. Let’s look at both sides of the medal. What are the drawbacks of these methods?
BNPL is a consumption smoothing mechanism, so you can buy without having to wait to actually own the money you’re about to owe. But there are many psychological aspects to borrowing money that need to be discussed when choosing to use these types of mechanisms: a) Due to the gratification of immediate urges this is a very “addictive” method of paying for things. Every need can be satisfied with the push of a button and express delivery options. The idea of waiting becomes so abnormal that it becomes a psychological impossibility. Not great for most aspects of life, as immediate gratification very often doesn’t lead to the best outcomes in contemporary society. b) There are psychological aspects that relate to the ability to live within one’s means as well. There’s the sense that if you don’t pay for something immediately, it’s free. People discount future rewards, but they also discount future costs, making the delayed cost of the product(s) be perceived as cheaper than it actually is. If you are a frequent user of BNPL systems this discounting may lead you to spend more than you can afford, as it’s perceived as cheaper. It may also make you order a lot more than you initially bargained for, as the perceived limit to your financial resources is not as harsh as it would be with cash or a stringent credit card limit or overdraft. This is one of the reasons that in the UK alone, these BNPL system have led to a consumer debt of over £4 billion. c) Another interesting aspect of this overconsumption is that people don’t seem to overconsume on products they actually need (surprise): “Research by Credit Karma found that almost half (48%) of BNPL purchases are made on nonessential items, such as electronics, cosmetics or holidays and 31% of Brits intend to increase their use of the service as the holiday season approaches.” Before you select a payment option, maybe ask yourself why you’re buying a certain item. And that question should be immediately followed by the question: “Do I really need it?” d) And similar to the credit card, people are not particularly able to track how much they have spent already, and when this money will actually be deducted from their accounts. In combination with the prior point, people overspend quite a bit, and if they fail to accurately keep track, they may find themselves unable to pay for all their purchases. A finding which has also been confirmed for the credit card. So these BNPL systems really aren’t too different at all. It’s just the millennial version of the same coin.
There are costs to BNPL systems which are a lot less psychological as described above, and much more financial in nature. If you do miss a payment, whether you can or cannot afford it, there’ll be a fine. These payments can be missed if they’re not set up as automatic payments or direct debits. Also, if they are set up but the account has insufficient funding and they bounce, that’s another fine for you. Also, if you do have missed payments or continue delaying payments, some apps will start charging interest to get at least some money back. So these systems may appear to be “free” in usage, given that this is a billion dollar industry, they’re really not. Just like credit card companies, they’re making money somehow… The knowledge that these mechanisms really aren’t free is especially important if you don’t have a stable income, or are financially vulnerable: you might choose to use BNPL systems because you don’t currently have the money, but if you’re not exactly certain you’ll be able to settle the next installment or the delayed payment either, maybe forego this method – because failure to fulfill will cost money as well.
Don’t think you’ll get away with not paying, missing payments or delaying them further and further. In addition to being fined, there’s also your credit score to consider. Although the BNPL systems are not credit cards in and of themselves, they are counted as loans. And loans impact your credit card score. In the US, 72% of people surveyed indicated having fallen behind on payments at least once when using these BNPL systems – which then directly impacted their credit scores. This is something a lot of people didn’t seem to be aware of, but yes, BNPL systems are also related to your credit score. So use them wisely!
There’s another issue that goes beyond psychology and finance: sustainability. I’ve already mentioned the ideas of over-ordering, ordering multiple sizes and the ease of returning them. From the consumer’s perspective, that’s all great, especially as these returns are often free. From the perspective of the company, given that a lot of people don’t return items as often as predicted, not even when it’s free to do so with lengthened time periods for doing so, there’s also still money to be made. So who’s really loses out here? The environment. For this particular example, let’s only look at online clothing retail. Most clothing consumed is fast fashion. And fast fashion is not exactly known for being environmentally sustainable (or really positive in any regard really). Over-ordering means increased production. BNPL systems promote increased ordering, even when the clothes aren’t necessarily being consumed (read: worn). In addition, when the consumer is smart enough to return the items that they are not going to wear, the return is not “free” in the least. Additional transport is required to deal with the masses of clothing either being ordered, or returned. Some web shops now display the amount of CO2 required to deliver their products, but I haven’t yet seen it for returns. And looking at the massive postal hubs from companies such as DHL, Royal Mail, Hermes etc. this business is booming.
From the environment to mental accounting, and from convenience to the psychology of living within one’s means, there’s many aspects to consider when using BNPL. I myself have used BNPL many a time and I have personally experienced how easy it becomes to just add that additional item to the online basket. And yes, I’ve also returned many an item – because it was too big, too small, or because I couldn’t even remember bloody ordering it. And yes, I also suddenly felt much more comfortable spending €500, whereas I normally would raise an eyebrow at a spend of over €100. I’m aware of every psychological trick behind this system and they still get to me. So don’t be too harsh on yourself, but do reflect on your financial situation and your financial goals, and make the educated decisions as to whether the BNPL system is really for you.