How 'buy now, pay later' became a coronavirus counter to credit cards

The COVID-19 pandemic has teed up a growth opportunity for the buy now, pay later (BNPL) financial industry, as recession worries made people receptive to entering short-term payment plans that can fit in a budget.

The broadening of the BNPL market to include both installment lending and deferred debit models has also made it easier for consumers and merchants alike to cozy up to this new generation of financial products that had already found success with millennials and Gen Z before the pandemic.

Because of the spotlight on the BNPL market, one company, Affirm, is reportedly considering a $10 billion IPO amid the pandemic. The BNPL market has become increasingly crowded with companies such as Klarna raising funds to compete and new players such as Afterpay and Splitit recently having gone public.

CORONAVIRUS IMPACT: ADDITIONAL COVERAGE
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Massive layoffs, businesses bankruptcies and store closures all due, in-part or completely, to the COVID-19-induced financial crisis have made people very concerned about taking on new debt and continuing to carry existing credit card balances. Data from a July 2020 Creditcards.com survey found that 62% of adults with credit card debt said they won’t be able to make minimum payments in the next three months if the pandemic continues. This is leading some consumers to rethink using credit card debt to fund purchases that they can’t pay for immediately in their budgets.

According to a new study by The Ascent, a personal finance brand of Motley Fool, which polled 1,862 adults over the age of 18 who use BNPL services, almost four in 10 (39.37%) respondents stated that they use BNPL specifically because they want to avoid paying credit card interest. Additionally, over 38% reported using BNPL services because it allows them to buy things that they cannot currently afford in their budget.

For those in the process of building their credit scores for future needs such as buying a house or financing an automobile, the ability to borrow without having a credit check was rather appealing to almost one-quarter (24.68%) of respondents. While only 14% stated that they can’t get approved for a credit card as a reason for using BNPL services, this number is likely to rise as many consumers are now experiencing credit line reductions and account closures for cards they already have in their wallets.
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Since the White House declared a COVID-19 national emergency in the U.S. in mid-March, there has been a steady pull-back on consumer revolving debt, probably due to a desire to shore up savings; and partly due to a lack of places to spend as as entertainment venues, sporting outlets and many retailers have closed or restricted access.

“We've been seeing a whole group of people using DailyPay that have not been financially impacted by the pandemic,” said Jeanniey Walden, chief innovation and marketing officer at DailyPay, an earned wage access provider. “They are pulling money out of their paychecks [wages earned but not yet paid] to pay down high cost debt such as credit cards. They are seeing an opportunity and are trying to improve their financial lives. We’re glad we can help them.”

Based on data from the August 4, 2020 Equifax U.S. National Consumer Credit Trends Report: Portfolio, consumer general purpose credit card balances have fallen from $818 billion on March 2, before the COVID-19 emergency declaration, to $727 billion on July 27, representing a drop of over 11% in just five months. Similarly, private-label credit card debt went from $76.9 billion on March 2 to $68 billion by July 27, a fall of roughly 11.5%.

Given that the average interest rate on credit card accounts being charged interest was 15.78% in June, according to the Federal Reserve Bank of St. Louis, paying down this debt can relieve a major consumer burden.
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One long-term factor favoring the BNPL industry is that consumers have for years been shifting their spending online.

Traditional BNPL loans from main street banks have relatively been concentrated in installment lending at POS for large ticket, in-store purchases such as furniture, with little coverage of e-commerce merchants. In contrast, PayPal Credit (formerly BillMeLater) Affirm, Afterpay and others were largely born in the e-commerce channel and have begun to migrate to the in-store channel. Fintechs have also focused on smaller-ticket items, often starting at $99, making them much more accessible to consumers with weaker credit histories and for everyday purchases.

Now with the COVID-19 crisis forcing store shutdowns and capacity restrictions, many consumers are finding themselves shopping online. Even as stores begin to reopen, many consumers have now become accustomed to the ease of e-commerce.

Take for example the U.K. retailer landscape, which has experienced a major shift to e-commerce. According to data from the U.K.’s Office for National Statistics, the U.K. market has gone from an average of 18% to 20% in online sales to over 30% as the country went into and out of a national lockdown.
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BillMeLater, which began in the early 2000s and was later acquired by PayPal’s former parent, eBay, in 2008 is often recognized as one of the forerunners of the modern BNPL fintech industry. PayPal had a homegrown competitive product called Pay Later, but it was folded into the new BNPL unit which contained BillMeLater, and rebranded as PayPal Credit.

Since then, there have been a number of high-profile BNPL companies that have entered the market from countries like the U.S., U.K., Sweden and Australia, and have begun to market their product across the globe.

Based on data from a study by The Ascent of U.S. adult BNPL users, a number of brands have experienced widespread adoption. In other words, while PayPal may have been one of the early innovators in this space, newer entrants such as Afterpay (Australia), Affirm (U.S.) and Klarna (Sweden) have been able to grab share in this growing market.

One of the likely reasons for such a broad-based adoption of BNPL has to do with merchant acceptance. Unlike credit cards, most merchants will accept only one or two BNPL brands. In contrast, most online merchants will accept multiple cards networks such as Visa, Mastercard, American Express, etc. According to a 2018 PaymentsSource report on the online BNPL industry, of 132 leading consumer brands selling on the internet, almost all accepted cards from the leading four card networks. In contrast, less than one-third offered a BNPL product and only a handful offered two brands.
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One major change in the last five or so years of the BNPL market has been the rise of the deferred debit model for making purchases. It changes the dynamic in who pays the fees to the length of payments and potentially reduces risks. In other words, it gives the BNPL market a second major product beyond the installment loan.

The traditional installment loan provides the funds upfront to make a purchase. Some companies offer introductory promotional interest rates to lure new customers with higher “Go-To” rates that often approach 29%, according to a 2018 PaymentsSource report on the online BNPL industry. Installment loans can sometimes be extended, but those come with deferred interest clawback clauses that make them potentially dangerous to consumers who do not pay them off in the original timeline.

In contrast, deferred debit typically just defers debiting of an account (mostly checking) for a short period of time. Companies such as Afterpay and QuadPay are emblematic of this new segment. Typically a consumer pays 25% upfront through an app, which uses their debit card, and the balance is split into three even payment amounts that are charged to the debit card every two weeks until paid off. The merchant pays a fee which is lower than typical credit card interchange. Consumers rarely pay any fees other than a late fee.
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If PayPal Credit (formerly BillMeLater) is an innovator of the BNPL installment loan segment, then Afterpay could be seen as one of the early innovators of the deferred debit segment. It is now one of the leaders driving deferred debit BNPL payments. The Australian-based company, now public on the Australian Stock Exchange, has experienced dramatic increases in consumer adoption in the last year, having launched in the U.K. in 2019 (under the ClearPay brand) and expanded its presence in the U.S.

In its last fiscal year, which ended June 30, 2020, Afterpay reported growing its active user base to 9.9 million customers, up from 4.6 million from June 2019. Additionally, Afterpay expanded its active merchant base to 55,400 companies in June 2020, up from 33,200 one year earlier. The U.S. now represents Afterpay’s largest market and that’s only two years after the company entered the country.

In July, Afterpay redesigned its mobile app to use its online deferred debit BNPL payment method for in-store leveraging Apple Pay and Google Pay.
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