How Buy Now, Pay Later Is Changing Household Finance

Credit, or the ability to borrow money, is an important part of economics and finance.  Without the ability to borrow, economic growth would be extremely slow.  The gross private domestic investment (IG) sector of gross domestic product (GDP) consists largely of loans to finance capital goods (commercial equipment) and business expansions.  In recent decades, the number of consumers using credit to make purchases has drastically increased.  

Consumer Credit Options

Credit Cards

Much consumer use of credit is done via short term loans through credit cards rather than loans.  When a purchase is made using a credit card, the credit card company pays for the good or service at the time of purchase.  At the end of the billing cycle, the consumer is expected to pay back the credit card company.  Any amount that the consumer does not pay back in full is subject to a high rate of interest - often exceeding 20 percent.  The convenience of credit cards makes them popular with virtually all consumers, but can lead to overspending.  As of December 2024, Americans had a collective total of $1.21 trillion in credit card debt, with $45 billion added in Q4 of that year.

Installment Loans

Some major purchases are paid in full by the consumer, with the money gotten from a bank or credit union through an installment loan.  These loans are paid back in fixed monthly installments.  Auto loans are a common example, with purchasers of new cars owing a fixed amount of money each month for a predetermined number of months.  When the last payment is made, the loan is paid off and the title of the vehicle transfers from the bank to the driver.  These loans can also be taken for other major purchases, such as appliances or home improvement projects.

Buy Now Pay Later (BNPL) Plans

Installment loans charge interest, and credit cards charge interest on unpaid balances at the end of each billing cycle.  A popular new service that helps consumers access credit is buy now, pay later (BNPL).  This service, which is offered by many credit cards and online payment companies like PayPal and Cash App, breaks the large price for an appliance or other expensive good into four or more smaller payments that the account holder can make over several months.  If the payments are made on time, no interest is charged - just like on a credit card.  Late payments, however, can result in expensive fees and/or the debt being turned over to a debt collection agency.

Popularity of BNPL

Elasticity of Demand

Buy now, pay later (BNPL) is popular because it spreads out payments in smaller chunks, which seem more manageable.  Consumers are more sensitive to high prices and are more likely to walk away from a purchase if a high price increases further (based on the principles of price elasticity of demand).  However, the proportionality also works the other way, with many more consumers willing to buy an expensive product when the price drops.  Being able to drop the point-of-sale price of an expensive item draws in a proportionally greater number of customers.  

Separate From Credit Score

BNPL is also popular with many consumers because it is independent of one’s credit score, meaning even those who cannot access loans or credit cards can use the service through online payment services like PayPal, Klarna, and Cash App.  It is also offered by many retailers directly.  Between 2021 and 2023, the number of Americans who had heard of BNPL, seen it offered, and used the services all increased significantly.  Users of BNPL tended to have lower credit scores than those who did not.

Regular Payments Allow for Better Budgeting

Some users may like BNPL because the interest-free division of payments allows for better budgeting than larger single payments.  Spreading a $1,000 appliance cost over four months at $250 per month helps “smooth” the family budget and build more cushion for other expenses, such as unexpected emergencies.  However, spreading the payments also means they carry into additional months, taking longer to “free up” budget space from the expenditure.  Some consumers may prefer this, as knowing they are still paying off a previous expensive good can dissuade them from making other luxury purchases.

Risks of BNPL:  Overconsumption and Delayed Default

The aforementioned budgeting benefits of BNPL only occur if the consumer is diligent and disciplined.  If consumers cannot refrain from making additional expensive purchases, even spread out BNPL purchases will eventually take up an entire budget.  Many consumers may overspend due to BNPL providing a false sense of financial security, not realizing that three additional monthly charges will occur.  BNPL can save consumers from spending too much during the first month, but crunch their budget during the second, third, and fourth months when additional purchases must still be made.

Eventually, the accumulations of BNPL purchases can cause default (failure to pay on a loan) by raising monthly credit card bills to an amount that cannot be paid.  Now the consumer will suffer from high interest payments, fees and penalties, and even being turned over to debt collection agencies.  Some consumers may intentionally take advantage of the fact that BNPL is separate from credit scores to maximize their ability to spend; taking out debt from multiple sources.  This can result in serious indebtedness and bankruptcy, seriously harming one’s financial future.

Why Firms Offer BNPL

If BNPL services are interest-free and potentially increase the risk that the seller will not be paid in full due to delayed default, why do companies offer BNPL?  First of all, BNPL significantly increases the firm’s customer base by reducing the money due at time of purchase.  Consumers with lower income can now access more expensive goods than usual, paying them off over time without first having to get a loan.  While some of the new, lower-income consumers may not be able to pay in full, the seller’s total revenue may increase enough to offset the individual losses.

Captive Market for Advertising

To sign up for BNPL, consumers have to input their data, which is valuable in and of itself to the seller and third party advertisers.  Those who sign up for BNPL services will find themselves subject to ads for related services and other sellers, manufacturers, and retailers who offer BNPL.  Sellers can now track BNPL users’ purchases and send them targeted advertisements for similar products, especially complementary goods.  Offering BNPL can also be used as an advertising hook by firms as they declare the service to be humanitarian in nature: “we offer buy now, pay later because we care about struggling consumers.”  Firms can say they offer BNPL as a way to get their product, and its benefits, into the hands of as many customers as possible to make society better.