‘It's lending on steroids': How Buy Now, Pay Later companies are meeting an influx of demand despite higher costs

In recent years, Buy Now, Pay Later (BNPL) companies have gained popularity alongside credit cards for holiday shopping. On Cyber Monday, BNPL purchases reached a record high, up 43% from the previous year, with shoppers using BNPL for larger purchases. Similar to credit cards, BNPL companies allow customers to make purchases without immediate payment, instead opting for interest-free installments over six weeks. Late payments may incur fees, and longer payment periods could have an annual percentage interest rate as high as 36%.

Initially, BNPL companies had low funding costs, which allowed them to lend to customers who might not qualify for traditional credit. Unlike credit card companies, BNPL companies typically do not conduct traditional credit checks or report missed payments to credit bureaus. However, as the Federal Reserve raised interest rates to combat inflation, BNPL companies faced higher costs for the money they loaned. Despite this, Affirm, one of the BNPL lenders, noted an increase in lending, particularly to new users who pose higher risks.

With interest rates at two-decade highs, BNPL companies are cautious about approving new consumers due to the possibility of missed payments. Affirm observed a slight increase in overdue loans in the past quarter. To mitigate these risks, BNPL companies focus on building relationships with repeat users, allowing them to gather more data and make informed lending decisions. For example, Affirm saw an increase in the share of transactions from repeat users over the past year.

Additionally, some BNPL providers offer rewards programs to encourage on-time payments and repeat usage, but their effectiveness is unclear. However, shoppers sometimes turn to multiple BNPL providers, leading to potential debt overload. As interest rates rise, BNPL companies are making fewer interest-free loans but still find value in their solutions, especially as rates increase.

BNPL companies generate income from interest on longer-term payment plans and fees from retailers. By offering retailers slightly less than the full purchase amount, BNPL companies enable them to receive payment from customers without available funds or access to other credit options. This arrangement often results in higher average order sizes as BNPL users can spread out payments. The extent to which BNPL companies renegotiate pricing with merchants due to rising interest rates remains undisclosed but is likely.