Is buy now, pay later the future or merely a fad?

Conventional wisdom has suggested that buy now, pay later (BNPL) is for young people without much money or credit history. That’s still mostly true, according to a new TransUnion report.

The credit bureau found that 71 percent of Americans have heard of BNPL and 38 percent have used one of these services within the past year. More than three in five of those customers (61 percent) are between the ages of 18 and 40. Since just 35 percent of the credit-active population falls within this age range, BNPL usage among Gen Zers and millennials is over-indexing by a factor of nearly two to one.

How the BNPL industry works

Popular BNPL services include Affirm, Afterpay and Klarna. A common option is to make four interest-free payments over six weeks. The terms vary widely, however. The plans can last for much longer and they sometimes assess interest. For instance, some of Affirm’s plans charge an APR as high as 30 percent. And I’ve seen BNPL plans lasting as long as 43 months (such as Affirm’s partnership with Peloton).

The BNPL industry has shrewdly joined forces with many high-profile retailers. Besides Peloton, Affirm also partners with Amazon, Walmart, Target and Lowe’s. Klarna has deals with Macy’s and Etsy, among others. And Afterpay, which was acquired earlier this year by Block, Inc. for $29 billion, works with big names such as Sunglass Hut, Ulta Beauty, Michael Kors and Adidas.

At first, these partnerships might introduce customers to the BNPL concept. If they’re on the fence about whether or not to make a purchase, obtaining easy access to financing at the point of sale can encourage them to buy. As the market has matured—it’s now a $100 billion industry—BNPL companies are benefiting more from repeat business. TransUnion says 71 percent of consumers with three or more point-of-sale financing inquiries on their credit reports used the same lender for all of these inquiries.

BNPL skews subprime (for now)

Because BNPL providers aren’t particularly selective from an underwriting perspective, it’s not surprising that TransUnion found 43 percent of applicants had subprime credit scores, versus just 15 percent of the total population.

The BNPL industry asserts that its delinquency and default rates are very low and that its risk management model is solid, especially since these are relatively low-dollar installment plans that last for a relatively short period of time. Critics argue that BNPL plans should be regulated more like traditional loans.

“The simplicity and convenience of BNPL and POS (point-of-sale) are driving consumer interest in these products,” said Salman Chand, vice president of consumer lending at TransUnion. “Consumers who are most likely to utilize point-of-sale financing tend to be younger and below prime. But as this market matures, we will likely see more consumers across the board becoming aware and starting to use these products.”

Are troubled waters ahead?

As much as BNPL is booming among consumers (global usage surged 29 percent during Cyber Week last November, according to Salesforce), the bloom has fallen off the rose from most investors’ perspectives. At the close of trading on May 31, Affirm’s stock was down 70 percent this year. In another sign of trouble, Klarna (which is privately held) recently laid off 10 percent of its workforce.

The sector has been hit by broader worries about higher interest rates and a global growth slowdown. Also, these are the kinds of high-flying yet often unprofitable tech companies that boomed along with e-commerce during the pandemic but now look less attractive.

Consumer spending has shifted more toward services and those nosebleed-inducing levels of e-commerce growth appear unsustainable. Ominous clouds are gathering on the regulatory front, too. The Consumer Financial Protection Bureau opened a formal inquiry into the business practices of five prominent BNPL providers late last year.

The bottom line

Despite these concerns, I still believe the BNPL industry has a bright future. Some business model challenges need to be worked out, and the industry appears ripe for consolidation, but there’s a strong use case for BNPL.

Many Americans, especially young adults, are drawn to BNPL because this financing is easy to obtain and pay off in predictable, pre-determined installments. In other words, they like knowing exactly how much they owe and for exactly how long. The interest rates can be much lower than credit cards, too (although they can also be higher, so check the fine print of your specific offer).

What I find most appealing is the fact that BNPL allows you to partition individual purchases so they’re separate from the rest of your finances. If you’re already among the roughly 50 percent of credit cardholders who carry expensive credit card debt from month to month, you may be wary of adding to that burden (and rightfully so). But paying for a $1,000 couch or television in preset installments via a BNPL provider might be cheaper and could free up needed cash flow.

About eight in 10 BNPL users have credit cards, according to TransUnion, so it’s usually not an either/or decision. In fact, some credit cards now offer BNPL options (installment plans). Most U.S. adults have access to both payment methods and they choose to deploy them selectively.

Have a question about credit cards? E-mail me at ted.rossman@bankrate.com and I’d be happy to help.