If you’ve been doing some online shopping lately, as many U.S. consumers have during the pandemic to avoid shopping in person (and maybe even just to pass the time while in quarantine), you might have noticed an increased recurrence of offers touting interest-free payments in installments.
Klarna, QuadPay, Affirm, Sezzle—these are just a few of the most familiar banking providers financing installment plans for e-commerce merchants. And as online purchases continue to increase and consumers look for more ways to save owing to COVID-19, “buy now, pay later” (BNPL) services have accelerated in popularity.
This week, PayPal is introducing a new BNPL product in the United States, dubbed “Pay in 4,” an interest-free installments plan. Consumers who opt for the plan can make a purchase and pay the merchant back over four interest-free installments, between $30 and $600, over a six-week period.
“Retailers are always looking for new and trusted ways to increase sales without taking on additional risk or costs,” says Doug Bland, senior vice president of global credit at PayPal. “The COVID-19 pandemic has accelerated the challenges they face, especially as we head into the holiday season. Similarly, consumers are looking for more flexible and versatile ways to pay, especially online.”
Buy now, pay later is not a new concept, notes Mark A. Cohen, director of retail studies at the Columbia University Graduate School of Business, underscoring that the practice has been the underlying basis of consumer credit since World War II and fueled the late 20th-century emergence of the American middle class.
“First, there were individual store accounts, largely built, like rent, on a pay-each-month basis,” Cohen explains. “Then there were retail store credit cards—à la Sears, Roebuck and Co.; Macy’s, etc.—which enabled customers to buy now and pay over time. These were hand in glove with store features like ‘layaway,’ which allowed customers to set aside merchandise typically for a small deposit or fee, which they could then pick up and pay for at a later date.”
While the groundwork for BNPL services has been set for decades, the sudden ubiquity is almost to be expected given the suddenness of the recent economic downturn. As the U.S. unemployment rate hit 10.2% in July (down from a peak of 14.7% in the spring), Cohen speculates that many consumers in the throes of the pandemic have been pressed to max out their credit cards to stay afloat. At the same time, credit card issuers, in turn, have likely lowered many customers’ credit limits as they have become far less creditworthy. Retailers—also suffering greatly as consumer spending has been soft—can respond here by offering interest-free BNPL services (so long as the customer pays within the prescribed window) to induce customers to shop now, not later.
“It enables shoppers—especially younger shoppers—to spend with some urgency, rather than wait or not spend at all,” says Wendy Liebmann, CEO of consulting firm WSL Strategic Retail. “That’s an advantage for categories like clothing, where in-and-out trends mean there is some urgency to buy. Waiting may not be an option, at least from an emotional standpoint.”
The payback
Pay in 4 will be included in the merchant’s existing PayPal pricing, so merchants won’t pay additional fees to enable it for customers, and PayPal takes on the credit risk. Retailers get paid upfront, and consumers pay no fees or interest if payments are made on time. Meanwhile, payments are conducted automatically and deducted from virtual wallets. Pay in 4 will also appear in customers’ PayPal wallets, so they can manage their payments in the PayPal app.
“We’re continuously monitoring the macroeconomic environment and the implications COVID has had. We’re committed to providing our customers with a range of choices in flexible financing during this time, which is why we’re launching new products like Pay in 4,” Bland says.
With more than 300 million consumer and merchant accounts in more than 200 markets, PayPal offers several other financing options along with Pay in 4. PayPal Credit, a reusable line of credit with various promotional offers built in, like six months of special financing and Easy Payments, is available in the U.S. and U.K. PayPal also offers PayPal Ratenzahlung and Paiement en 4X—installment products in the German and French markets—and Pay After Delivery, a buy now, pay later offering in Australia, Canada, France, Germany, Spain, the Netherlands, and the U.K. Pay in 4 is scheduled to be available to consumers on qualifying purchases in the fourth quarter of 2020.
The rapid growth and improvement of fintech brands over the past decade have broadened the market for BNPL services, says Gerard Griffin, CEO and founder of wage access and financial services firm AnyDay, from accelerating the credit underwriting process (now instant at the time of purchase where before it required manual preapproval) to broadening and expediting distribution (merchants can offer the service to customers via the existing merchant processor as opposed to developing capacity itself or negotiating an arrangement with a local bank).
Griffin suggests interest-free installment plans for online purchases are particularly popular with millennials, who might be wary of racking up credit card debt as many of them entered the workforce in the midst of the Great Recession.
“The credit crisis gave credit a bad name for those in their formative period then, I believe, leading to the declining use of credit cards among millennials,” Griffin explains. “Installment purchase offers instant purchase gratification without the ‘credit’ label.”
However, while the lure of smaller, interest-free payments might seem appealing on the surface, just like credit cards, those offers are dependent on consumers making payments on time. If they don’t make payments on time, again, just like with credit cards, those penalties rack up fast, and consumers face the potential of falling into a great amount of debt in a short amount of time.
“However you look at it, consumer credit balances were rising somewhat sharply pre-COVID and now are likely to drive an economic crisis whose dimensions and duration will be dependent on how long COVID-19 paralyzes our economy and how long it takes for us to truly recover,” Cohen says.
Therefore, it’s imperative for consumers to closely read the rules for payment plans before making purchases. “The interest rate is not always explicit, letting consumers feel they’re just paying for goods over time,” Griffin says. “I suspect current economic stress will lead to greater demand for buy now, pay later. But equally, it will increase the risk of default, so providers may rein back the offering.”
Put even more simply: There are no free rides anywhere, Cohen says. But retailers also shouldn’t overlook the risks in offering installment plans. “Whenever a consumer purchases something without paying for it, immediately there is a bill due,” he says. “As for the retailers offering this new/old form of credit, they face the challenging specter of slow-pay/no-pay consumers who they do business with in this way.”
“It’s easy for shoppers to get into unmanageable debt quickly, and for retailers, there’s the cost of merchandise bought but not paid for,” Liebmann concurs.
But, she says, even though shoppers need all the encouragement to buy these days, this trend is not only a pandemic story. Thus, there is reason to predict consumer interest in BNPL plans will continue for some time.
As customers continue to seek out different financing options, Bland expects the upward trend for pay schemes to continue growing. “As online shopping increases, consumers seek choice and flexibility, which includes the ability to pay over time,” he says. “Merchants will continue to require innovative, diverse payment options for customers.”
