Lending Perspectives: Is Buy Now, Pay Later a Plate of Cookies or a Lump of Coal?

If you haven’t been paying attention to buy now, pay later lending, perhaps the holidays are a perfect time to take notice. In the last few months, there has been a flurry of news in the financial press on the rise of BNPL lenders. While this new breed of lenders existed before COVID-19, it seems as though there has been a tremendous increase in momentum for consumers to utilize BNPL and repay in a three- to 12-month period rather than use a credit card or cash to make mid-priced purchases, including this article on CUmanagement.com

There is plenty of news, but is the opportunity for credit unions to capitalize on BNPL more like a plate of Santa’s cookies or a lump of coal in your stocking?

Understanding the Buy Now, Pay Later Models

From my initial analysis of the major players in the BNPL market, there are three primary business models.

1. Merchant-funded. There is no such thing as a free lunch. If consumers have access to money and can repay it in time, there are costs involved. For the lenders that offer 0% interest, someone’s paying for it, and primarily it’s the merchant. I tend to see more of this with online merchants. They may not have the physical facilities of traditional retailers; they may also be leveraging convenience to charge a slightly higher price. Regardless, the merchant is paying the BNPL lender for the cost of the 0% financing. Of course, it’s the consumer who ultimately pays via a higher price. That said, most online merchants report that BNPL has resulted in increased consumer spending, which may justify the cost of providing the free financing.
2. Consumer-paid. These lenders are charging traditional interest for a short-term loan. In most cases, the interest rate is less than many of the higher-rate cards on the market. What’s the appeal to the consumer? Increasingly, younger consumers are becoming disenchanted with credit cards. While interest rates are at historical lows, credit card rates are at historical highs to fund the cost of increasingly attractive rewards programs. Consumers want the comfort of knowing their $1,000 sofa will be paid for in 12 months, and not be “lost,” mixed with other purchases, on a credit card that simply doesn’t get paid down.
3. A payment option on a credit card. The major credit card issuers are increasingly offering their customers the option to segregate major purchases and pay them off in given number of months. For the consumer, it’s as simple as accessing their account online, looking for recent purchases and selecting a specific payment plan for them. Clearly, this is the card industry’s response to the constant assault on their business model. I’ve written a past column about how personal loans and the fintech industry have siphoned off balances from consumers carrying balances who not only want to know their debt will be repaid over a specific period, but also want to reduce their interest rate.

Threat, Opportunity or Nuisance?

I suppose I could have phrased my strategic question about BNPL for credit unions like this: “a Christmas Eve blizzard, Santa’s cookies or a lump of coal?” But the bottom-line issue is what credit unions should do to react to the emerging trend of BNPL.

I’m an old finance company guy, having spent five years in that industry before my 33 years in the credit union movement. I believe the near-death experience of the finance company industry in the Great Recession opened the door for BNPL on larger-ticket purchases from physical location merchants. Financing consumer good purchases of $500 to $5,000 was a way for finance companies to get consumers in the door, so to speak.

Technology and the growth of virtual or digital merchants allowed BNPL to finance much smaller purchases. Just this week, I ordered some customized address labels for my bride, who still actually writes letters to her friends and family. I was offered the option to have four equal payments through Afterpay on my $24 purchase! Offering credit on a small-ticket purchase like that makes no economic sense without a high level of technology.

Frankly, the BNPL trend requires your credit union to separate the hype from the reality. As fintechs, the BNPL companies are driven by growth in balances and number of customers. That growth fuels investment, which drives even more growth. Ultimately, the end game is an acquisition and cash-out. To get to that end game, the fintechs need a lot of hype.

The reality goes back to the fundamental challenges credit unions face when it comes to personal loans and credit cards. To compete in the personal loan market, your credit union needs an outstanding user interface that members use to apply. Decisions have to be made quickly—almost immediately. Self-service tools and digital signatures are a must—not only for your members’ convenience, but for your staff’s efficiency. Your credit union’s risk tolerance has to be adequate to help a broad cross-section of members consolidate debt. Frankly, your credit union can’t be afraid of large loans or small ones.

Credit card offers have to be diverse enough to not only appeal to big spenders and their need for rewards, but to your members that pay interest and carry a balance. In other words,you can’t put the cost of rewards solely on the backs of your members who pay interest. That strategy for card program management is pushing rates higher for consumers, which can drive them to fintechs for consolidation loans and BNPL. In all, this situation is why card issuers are finding it difficult to grow balances, and fintechs, whether in the personal loan or BNPL market, are getting all the press—and the cookies.

Bill Vogeney is the chief risk officer and self-professed lending geek for $8.6 billion Ent Credit Union, Colorado Springs.