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Americans are racking up 'phantom debt' that Wall Street can't track

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It’s hard enough for central bankers and Wall Street traders to make sense of the post-pandemic economy with the data available to them. At Wells Fargo, senior economist Tim Quinlan is particularly spooked by the “phantom debt” that he can’t see.

That specter lurks behind buzzy “Buy Now, Pay Later” platforms, which allow consumers to split purchases into smaller installments. The major companies that provide these so called “pay in four” products, such as Affirm Holdings, Klarna Bank and Block’s Afterpay, don’t report those loans to credit agencies.

Time and again, they’ve resisted calls for greater disclosure, even as the market has grown each year since at least 2020 and is projected to reach almost $700 billion globally by 2028. That’s masking a complete picture of the financial health of American households, which is crucial for everyone from global central banks to U.S. regional lenders and multinational businesses.

Consumer spending in the world’s largest economy has been so resilient in the face of stubbornly high inflation that economists and traders have had to repeatedly rip up their forecasts for slowing growth and interest-rate cuts. Still, cracks are starting to form. First it was Americans falling behind on auto loans. Then credit-card delinquency rates reached the highest since at least 2012, with the share of debts 30, 60 and 90 days late all on the upswing.

There are signs that consumers are struggling to afford their BNPL debt, too. A recent survey conducted for Bloomberg News by Harris Poll found that 43% of those who owe money to BNPL services said they were behind on payments, while 28% said they were delinquent on other debt because of spending on the platforms.

For Quinlan, a major concern is that economic experts are being “lulled into complacency about where consumers are.”

“People need to be more awake to the risk of BNPL,” he said in an interview.

Blame game

BNPL is a black box largely because of a longstanding blame game among BNPL providers and the three major credit bureaus: TransUnion, Experian and Equifax. The BNPL companies don’t provide data on their installment loans that are split into four payments, which were used by online shoppers to spend an estimated $19.2 billion in the first quarter, according to Adobe Analytics, up 12.3% compared with the same period last year.

The BNPL behemoths say credit agencies can’t handle their information — and that releasing it could harm customers’ credit scores, which are key to securing mortgages and other loans. The big three bureaus say they’re ready, while two of the major credit scoring firms, VantageScore Solutions and Fair Isaac Corp., say they’re equipped to test how the products will affect their figures. Meanwhile, regulation is looming over the industry, but this stalemate has left the status quo mostly in place.

There have been signs of progress. Apple earlier this year became the first major BNPL provider to furnish transaction and payment data to Experian. As of now, it provides a snapshot of consumers’ overall debt load from Apple Pay Later transactions, but the information won’t be used for consumer credit scores.

In separate statements to Bloomberg, Klarna, Affirm and Block said they want assurance that consumers’ credit scores and their data would be protected before reporting customer information. Representatives for TransUnion, Experian and Equifax said they’ve updated their structures and the data would be secure.

All the while, the lack of transparency has researchers at the Federal Reserve Bank of New York, which publishes a comprehensive quarterly report on the $17.5 trillion in household debt, convinced they’re missing some of what’s happening in the economy.

“They’ve reached a certain scale that they could impact economists’ assumptions about their economic outlooks,” said Simon Khalaf, Chief Executive of Marqeta, a firm that helps BNPL providers process their payments.

Hiding consumer distress

The Harris Poll survey, conducted last month, provides some crucial clues about how Americans use BNPL. For one, splitting payments into smaller chunks encourages more spending.

More than half of respondents who use BNPL said it allowed them to purchase more than they could afford, while nearly a quarter agreed with the statement that their BNPL spending was “out of control.” Harris also found that 23% of users said they couldn’t afford the majority of what they bought without splitting payments, while more than a third turned to the services after maxing out credit cards.

The findings also show that the spending, which for more than a third of users has exceeded $1,000, isn’t entirely on big-ticket items. Almost half of those using BNPL say they’ve started, or have considered, using it to pay bills or buy essential items, including groceries.

So far, the small pockets of consumer distress that have emerged in the US have been chalked up to a bifurcated economy where working class Americans struggle to make ends meet. But the survey found that middle-class households are relying on BNPL, too.

About 42% of those with household income of more than $100,000 report being behind or delinquent on BNPL payments.

“BNPL essentially lets people dig a deeper and deeper hole of credit, which will be harder and harder to climb out of,” said Ed deHaan, a professor of accounting at Stanford Graduate School of Business, adding that it happens “more easily when there’s no transparency.”

How it works

The option to pay in installments using short-term loans has been around for several years, but exploded in popularity during the pandemic, especially with younger, digitally savvy consumers who gravitated to the services as an alternative to credit cards. The pioneering BNPL companies, including Afterpay, Klarna and Affirm, launched with trendy retailers, partnered with social media influencers and became a common option on apps and online checkouts.

BNPL offers quick credit approvals and lets consumers pay in installments. The first is usually due right away, and the others are often collected once every two weeks for the popular “pay in four” loans. There’s typically no interest or fees, as long as payments are made on time. Like credit card companies, BNPL firms make money on fees from merchants — and some have steep penalties for missed payments.

The rapid adoption of the products has enticed major financial institutions to offer the option to split payments, even as regulators warn them of the risks. That includes PayPal Holdings, U.S. Bancorp and Citizens Financial Group. Even big banks like Citigroup Inc. and JPMorgan Chase have similar capabilities on their credit cards.

The industry has branded itself a financial equalizer. They argue that “soft-credit checks” — when a lender runs a consumer’s credit history without affecting their score — expand credit access to those underserved by traditional lenders, while zero-interest provides a better deal than many cards.

Affirm said its customers have an average outstanding balance of $641, while Afterpay and Klarna put the figure at $250 and $150, respectively. The average credit card balance was $6,501 in the third quarter of 2023, according to Experian data.

Still, critics argue BNPL is particularly attractive to the financially vulnerable. The Consumer Financial Protection Bureau has flagged risks to consumers, including surprise late fees and “hidden interest” — or when BNPL purchases are made with credit cards charging high interest rates. The CFPB has also expressed concern about “loan stacking,” when individuals take out several BNPL loans at once with different providers.

Some BNPL services, including Afterpay and Klarna, require borrowers to agree to “mandatory autopayment,” meaning the companies can automatically charge the credit card or bank account on file when a payment is due. Those who link the latter are potentially vulnerable to overdraft fees.  

Stretched thin

Robust consumer spending and low unemployment rates have many economists convinced the consumer remains strong, making Wall Street bullish on the economy. But lately, stubbornly persistent inflation has dialed back expectations for imminent interest-rate relief.

That’s set to ramp up pressure on households that are already stretched thin by higher prices for everything from gas and food to rent and apparel. As of the end of December, almost 3.5% of credit-card balances were at least 30 days past due, according to the Philadelphia Fed, the most since the data began in 2012. Nominal card balances also set a new high.

For those who are falling behind, BNPL offers what appears to be a no-brainer decision: space out payments.

That was the thinking of Hayden Waschak, a 23-year-old in Pittsburgh. Even though he said it felt “dystopian” to use BNPL to pay for food, he began using Klarna in February to spread out payments on a grocery delivery app.  

It helped his finances — at first. After he lost his job as a documents processing specialist at University of Pittsburgh Medical Center in March, he relied more heavily on the service. And without any income, he became delinquent on payments and started racking up late charges. He eventually paid off the nearly $200 balance, but he said his credit score dropped.

“Unexpected life events caused me to lose income,” Waschak said. “I ended up paying more than if I had paid for it all at once.”

A representative for Klarna said the company doesn’t report data to credit bureaus and “therefore consumer credit scores are not negatively impacted when using Klarna’s BNPL options.”

Debt collection

The BNPL providers’ stalemate with the bureaus means users get little upside when it comes to their credit — paying on time won’t help them build up their score. On the other hand, the downside is still there for falling behind: not only can they get charged late fees, but delinquent BNPL loans can be turned over to debt collectors.

The latter is what Fabrizio Lopez said happened to him. He used Affirm to split up a $500 online payment for used-car parts five years ago. The Long Island-based mechanic, who doesn’t have a traditional credit card, said that while he received the items a week later, he never got a bill. That is, until debt collection letters started pouring in from across the US.

Lopez said he primarily relied on cash before that purchase, so the unpaid loan stands out on his credit profile. Now 30, he worries that a the BNPL purchase has created “invisible barriers” to the financial system.

“They hook you with the idea of no interest rates,” he said. “I thought that I would be able to build my credit if I paid it back — I was so wrong.”

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Paulina Cachero and Paige Smith, Bloomberg , 2024-05-14 21:48:13

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