How buy now, pay later services are driving Gen Z into debt

Digital payment products are attracting young consumers with little credit history who see them as alternatives to credit cards

The financial products typically let consumers pay for purchases in four instalments, with the promise of little to no fees, no interest and quick credit approvals. PA

Sarah Pfefferle had already saved $16,000 for her future home by the time she was 18. Then she started using buy-now, pay-later (BNPL) products and “ruined everything”.

In only two months, the Chicago native racked up $5,000 in debt across three of the instalment loan companies.

The ballooning balances drained much of her savings and prompted her to seek help from a financial adviser. But the damage was done: Ms Pfefferle’s credit score dropped to 580 from 720 after she closed her accounts.

Ms Pfefferle, now 21, said her plan to buy a house has been set back at least two years. And she fears she won’t be able to get a mortgage.

“I have little to no money saved for emergencies,” she said. “It’s a vicious cycle.”

Ms Pfefferle is hardly alone.

Australian company Afterpay popularised the concept of buy now, pay later as a new spin on layaway plans with an instant gratification twist. The financial products typically let consumers pay for purchases in four instalments, with the promise of little to no fees, no interest and quick credit approvals.

That enticed young consumers with little credit history, who saw BNPL as an alternative to credit cards for the TikTok generation.

The pioneering companies, including Afterpay, Klarna and Affirm, launched with hip clothing retailers, struck brand deals with social media influencers and quickly became ubiquitous on apps and online checkouts.

They make most of their money by charging merchants a fee each time a consumer uses the product at checkout.

The short-term loans surged in popularity during the Covid-19 pandemic, thanks to consumers who were flush with extra cash and limited to shopping online.

Five major BNPL companies originated 180 million loans totalling $24.2 billion in 2021, a near 10-fold increase from 2019, according to a report from the US’s Consumer Financial Protection Bureau (CFPB).

The promise of interest-free payments made BNPL products particularly attractive to credit card-wary Gen Z.

However, BNPL is “only free when you follow all the rules”, said Ed Mierzwinski, a senior director of the US Public Interest Research Group.

The BNPL companies have been plagued by delinquency this year as inflation bites.

The CFPB found that younger borrowers are more likely to have loans in “derogatory status”, meaning they’re either in default or sent to a third-party debt collector.

Roughly 11 per cent of borrowers paid at least one late fee in 2021, an increase from the prior year. And 18 per cent of consumers aged 18 to 29 fell behind on payments in 2021, according to a Federal Reserve report.

“The marketing here is counting on a younger, perhaps less financially sophisticated spender because they haven’t been in the financial marketplace as long,” Mr Mierzwinski said.

In emailed statements, Afterpay, Klarna and Affirm all said they provide more consumer safeguards than credit cards and emphasised that they don’t charge interest and either don’t charge late fees or cap them.

For Gabrielle, who asked that her last name be withheld, it didn’t feel like she was spending money because her BNPL payments weren’t due for weeks. And the more she spent, the more credit she got.

More than a year later, the 19-year-old was left with a heap of new clothes, make-up and $3,500 in debt with balances across several BNPL apps.

She was eventually able to pay off her balances in April after seeking help on a Reddit forum, where many users said BNPL apps fuelled their shopping addictions.

For some, falling behind on BNPL payments could have long-lasting consequences.

Briana Gordley, 24, said she didn’t understand the hidden pitfalls of BNPL when she first encountered an Afterpay advertisement at the clothing retailer Forever 21 in 2016.

Paying her own way through college and rejected by credit card providers, the then-freshman believed the financial offering was a safe way to pay for things she couldn’t afford with her part-time job.

Only 18 months later, the Texas native had spent $1,500 across three platforms, and three of her loans had been sent to collections. She was forced to turn to her parents for help.

And even then, it took her two years to finally build a savings account and start paying down her student loans.

While Ms Gordley’s late payments didn’t affect her credit score, that may not be the case for borrowers in the future.

Major credit bureaus like Equifax and Experian have said they’ll start including BNPL purchases on consumers’ credit reports, although not all lenders are reporting data to them yet.

Loans sent to debt collectors can also be reported, which can hurt consumers’ credit scores.

Ms Gordley told the Senate Banking Committee in September that BNPL targets younger borrowers who are only learning how to manage their own finances, and said the products verge on being “predatory” without strong disclosures and consumer protections.

“I understand and believe in personal accountability and responsibility for the choices I made,” Ms Gordley said. “But accountability and responsibility should be a two-way street between consumers and businesses.”