Americans taking on more ‘phantom debt’
“Buy now, pay later” loans helped fuel a robust 2023 holiday shopping season. Economists worry they could also be masking and exacerbating cracks in Americans’ financial well-being.
The loans, which allow consumers to pay for purchases in installments, often interest-free, have soared in popularity because of high prices and interest rates. Retailers have used them to attract customers and to get people to spend more.
But such loans may be encouraging younger and lower-income Americans to take on too much debt, according to consumer groups and some lawmakers. And because such loans aren’t routinely reported to credit bureaus or captured in public data, they could also represent a hidden source of risk to the financial system.
“The more I dig into it, the more concerned I am,” said Tim Quinlan, a Wells Fargo economist who recently published a report that described pay-later loans as “phantom debt.”
Traditional measures of consumer credit indicate that U.S. household finances overall are relatively healthy. But, Quinlan said, “if those are missing the fastest-growing piece of the market, then those reassurances aren’t worth a darn.”
Estimates of the size of this market vary widely. Quinlan thinks that spending through pay-later options was about $46 billion last year. That is small when compared with the more than $3 trillion that Americans put on their credit cards in 2022.
But such loans — offered by companies like Klarna, Affirm, Afterpay and PayPal — have climbed fast at a moment when the finances of some Americans are showing early signs of strain.
Credit card borrowing is at a record high in dollar terms — although not as a share of income — and delinquencies, although low by historical standards, are rising. That stress is especially evident among younger adults.
People in their 20s and 30s are by far the biggest users of pay-later loans, according to the Federal Reserve Bank of New York. That could be both a sign of financial problems — young people may be using pay-later loans after maxing out credit cards — and a cause of it by encouraging them to spend excessively.
Liz Cisneros, a 23-year-old college student in Chicago who works part time at Home Depot, said she was surprised by the ease of pay-later programs. During the pandemic, she saw influencers on TikTok promoting the loans, and a friend said they helped her buy designer shoes.
Cisneros started using them to buy clothes, shoes and Sephora beauty products. She often had multiple loans at a time. She realized she was overspending when she didn’t have enough money while in a grocery checkout line. A pay-later company had withdrawn funds from her bank account that morning and she had lost track of her payment schedule.
“It’s easy when you keep continually clicking and clicking and clicking, and then it’s not,” she said, referring to when she realizes she has spent too much.
Cisneros said the problem was particularly intense around Christmas, and she did not shop during the recent holiday season so she could pay off her debts.
Pay-later loans became available in the United States years ago, but they took off during the pandemic when online shopping surged.
The products are somewhat similar to the layaway programs offered decades earlier by retailers. Online shoppers can choose from pay-later options at checkout or on the apps of pay-later companies. The loans are also available at some physical stores; Affirm said Tuesday that it had started offering pay-later loans at the self-checkout counters at Walmart stores.
The most common loans require buyers to pay one-quarter of the purchase price upfront, with the rest usually paid in three installments over six weeks. Such loans are typically interest-free, although users sometimes end up owing 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 a few 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’re able to identify and extend credit to consumers who have the ability and willingness to repay above that of revolving credit accounts,” Michael Linford, Affirm’s chief financial officer, said in an interview.
Kelsey Greco made her first pay-later purchase about four years ago to buy a mattress. Paying $1,200 in cash would have been difficult, and putting the purchase on a credit card seemed unwise. So she got a 12-month, interest-free loan from Affirm.
Since then, Greco, 30, has used Affirm regularly, including for a Dyson hair tool and car brakes. Some of the loans charged interest, but she said that even then she preferred this form of borrowing because it was clear how much she would pay and when.
“With a credit card, you can swipe it all day long and be like, ‘Wait, what did I just get myself into?’” said Greco, a Denver resident. “Whereas with Affirm, it’s giving you these clear-cut numbers where you can see, ‘OK, this makes sense’ or ‘This doesn’t make sense.’”
Greco, who was introduced to The New York Times by Affirm, said pay-later loans helped her avoid credit card debt, with which she previously had trouble.
But not all consumers use paylater options carefully. A report from the Consumer Finance Protection Bureau in 2023 found that nearly 43% of pay-later users had overdrawn a bank account in the previous 12 months, compared with 17% of nonusers.