Buy Now, Pay Later and the New Consumer Debt Cycle

Debt is a significant facet of modern economics, especially Keynesian economics.  Since the Great Depression, and World War II following immediately afterward, most nations have been willing to engage in deficit spending to maintain aggregate demand during the face of economic crises.  This involves taking on additional debt, which most national governments do by selling bonds.  People buy these bonds, giving the government cash, and they receive interest for a period of time before receiving back the principal - or face value - of the bond.  These government bonds are typically guaranteed by the full faith and credit of the issuer and the interest payments (profit to the purchaser) may be tax exempt.

Deficit spending, and the resulting debt, are useful in allowing governments to spend significant amounts of money when needed during emergencies, such as a war, natural disaster, pandemic, or other economy-wrenching externality (outside factor).  This spending can prevent a recession from occurring and keep thousands of workers on the job.  However, the bonds must be paid as promised; if the government defaults (fails to pay) on those bonds they will struggle to sell more in the future.  Unfortunately, many nations today are considered at risk of defaulting on their debts.

It’s not just governments that we study in Economics when it comes to debt: borrowing money is also a tool of firms and consumers.  This debt fuels aggregate supply when it is taken on to invest in new capital goods that generate output for a business, such as new factory robots, tractors, or office equipment.  Aggregate demand is fueled when debt is taken on for consumers and businesses to purchase goods and services, such as personal vehicles, luxury goods, and vacations.  

Traditionally, debt occurs when firms or individuals take out loans from banks.  They use the amount of the loan to buy the goods (capital or consumer goods) and pay off the bank over time with monthly installments, including interest.  However, taking out loans from banks can be time-consuming and cumbersome, and many individuals may only do it for major purchases like a house or a new car.  For smaller items, sellers can allow in-store financing, where a payment plan is made.  This can include delayed payment, where the customer takes the product at the time of purchase but makes payments at a later date.

Why Do Consumers Prefer Delayed Payment?

Delayed payments are not uncommon; we see them advertised frequently: “No payment for 90 days!”  Expensive goods like furniture, appliances, and automobiles are frequently offered with some degree of in-store financing and delayed payment.  If customers fail to make the payments as promised, of course, the products are taken back by the seller, which still legally owns them.  A common example is the repossession of automobiles, with approximately 7 percent of auto loans in the United States being at least 60 days late.

Psychology

Buying now and paying later in installments (periodic payments, usually monthly) is psychologically appealing to many consumers, as they feel like they are paying less overall.  With new buy-now-pay-later (BNPL) services like Klarna and PayPal, consumers can access this type of payment on most major purchases.  These services let consumers buy the product immediately buy pay over time to the BNPL service, often without interest.  In this regard, BNPL is better for consumers than traditional loans, which charge interest.  Interest-free BNPL services may tacitly encourage more consumer spending because they feel like they are getting a deal (consumer surplus).

Initial research has shown consumers preferring BNPL to large one-time payments, with users spending about 10 percent more in their retail basket when able to use BNPL.  This increase in consumption with BNPL continues over time, leading to a long-term increase in spending.  Researchers discovered that a significant reason for increased BNPL spending was that the smaller installments felt less significant and thus easier to mentally justify.  Demand is more price inelastic, meaning less likely to change, when prices are low; consumers feel that price changes are more “trivial” and less likely to affect their economic well-being.  As a result, they continue with the purchase.

Economics

Interest-free BNPL services may encourage additional consumer spending by being seen as offering more purchasing power than loans or credit cards, where interest must be considered.  Traditionally, a customer would have to pay interest to finance the purchase of a major item, thus making interest-free BNPL services an economic benefit.  This encourages more spending than would occur otherwise.  

A second economic benefit to BNPL services is the ability to mitigate the effects of inflation.  During periods of high inflation, consumers are encouraged to purchase goods and services as soon as possible to avoid rising prices, which is the demand determinant of future prices.  Before interest-free BNPL services, consumers looking to beat inflation by purchasing major items immediately would have to borrow money and pay back interest.  If consumers could not borrow money, such as due to having low credit scores, they would have to save up money to make the purchase at full price.  Due to rising prices, this could take longer than expected, forcing many consumers to go without the product.  

How Firms Use This to Their Advantage: Increased Basket Size and Conversion Rate

If you don’t have to pay full price now, and can spread payments over a long period of time, you are likely to purchase more items and increase your basket size (also known as your digital shopping cart).  Therefore, firms have an incentive to allow customers to use BNPL services, especially since the services pay full price at the time of sale.  This removes the risk from traditional store financing of customers defaulting on their monthly payments.  When BNPL services, which include many credit card companies, pay full price for the sale, they are responsible for dealing with clients who fail to pay back as promised.  Most do eventually, with interest for missed payments, or these companies would stop offering these services.

Conversion Rate

BNPL services lead to higher conversion rates, which are the rates of customers completing sales.  Online, many customers explore goods and services, and may even add them to their basket, but ultimately do not purchase.  Along with increasing sales overall, BNPL services increase conversion rates.  People are more willing to buy now, likely due to a combination of increase inelasticity of demand due to perceived lower payments and the increase in demand due to expectation of higher future prices.  Perceived lower prices today and expected higher prices tomorrow help lock in consumer purchases!

Risks of Debt

Although many BNPL services are interest-free, consumers can still end up in significant debt through principal alone.  If you only have $500 in your bank account, but spend $600 on goods that can be paid through an interest-free BNPL service, you are still in debt.  Many consumers may spend more than they should because they assume that they will make enough income in the near future to manage the upcoming payments.  This situation is similar to consumers taking out sizable loans on new houses and cars, estimating that they will receive higher income soon that will make the loans more manageable.  If a recession occurs, many of these consumers may struggle due to lack of raises and promotions, or even job and income loss.

Demands for Regulation of Buy-Now-Pay-Later

When BNPL services became popular a few years ago, one dilemma some encountered was the difficulty in getting refunded for returned purchases.  Because payments for products had been made through a third party BNPL service, consumers were sometimes at a loss as to how to pursue a refund.  In 2024, the United States Consumer Financial Protection Bureau passed new regulations to require BNPL services to provide the same client rights as credit card companies.  Under the Truth in Lending Act, when returns are made, the BNPL service must credit the customer’s account.  BNPL service companies must also provide clients with regular billing statements so they can view their itemized charges and obligations.