It’s been sneaking up, and it may be the next millennial disaster. Companies such as Affirm, AfterPay, and Klarna are making it easy for people to get a simple installment loan for everyday products. And that’s both good and bad.
Under Buy Here, Pay Later, consumers can go through a third-party lender for small purchases. Rather than pay for a $300 dining set today, they can set up an installment loan for up to 24 months. They then pay the third-party lender back for that purchase. They don’t need to use a credit card, and often they don’t even need a credit check.
For the merchant, this is great. It encourages customers to make purchases that they wouldn’t otherwise be able to afford. For the customer, it seems great. They’re able to buy things now and pay later. But there’s a more insidious issue — customers may be able to overextend themselves significantly by leveraging these options.
These options can have percentage rates up to 30%, which is higher than most credit cards. Customers will be paying interest not on big ticket items, but on very small household items, clothing, and cosmetics. This normalizes getting installment loans for very small things.
Why Are These Micro-Installment Loans Bad?
Installment loans aren’t necessarily bad. They can be very useful. But they do have consequences. These loans aren’t really “installment loans,” but rather “micro loans.” Micro loans only give you a little money, but they go through the entire process of a loan, including hitting your credit report.
For customers, installment loans look like a win/win. They can get what they want now, and break it into small, manageable payments. But consumer debt has been rising. The more consumer debt there is, the less stable the economy becomes. As credit cards and installment loans go up, consumers will find it more difficult to buy things like houses and cars.
Moreover, each installment loan does hit the customer’s credit report, which is something that not every customer realizes. These new loans will lower credit age and increase the amount of overall debt that the customer has, thereby impacting their credit score. Again, this can impact the customer and the economy in many ways. When customer borrowing power is reduced, banks suffer.
And, of course, if a borrower is late on their payments it can dramatically reduce their credit score. This is something that a customer might take months to recover from. With numerous installment loans, it becomes more likely that customers could accidentally overdraft their accounts or otherwise forget to pay.
Why Are Buy Here, Pay Later Companies Thriving?
But from an investor perspective, these companies are an incredible opportunity. Since they appear to be a win/win for both customer and company, people are very eager to use it. People look for these companies: If they have an Affirm account, they’ll be looking to make a purchase with an Affirm company. Companies are starting to learn this, and are thus increasing their adoption.
It’s likely that these companies are going to continue to proliferate across the internet, because they are so alluring. The companies themselves are undoubtedly making a lot of money. An installment loan, unlike a credit card, has to be paid off through scheduled payments. These payments are automatically deducted from a bank account. Thus, they have a much lower rate of default than many other lending options.
Investors who are interested in financial instruments should keep an eye on these companies, because they are companies that are going to thrive when the economy does crash. When the economy crashes, people are going to still want to make purchases, but will have reduced cash purchasing power.
For customers, it may be best to avoid it. There’s never an advantage to paying with an installment loan over cash, and there are very few situations in which an individual needs a product right away. Most Buy Here, Pay Later companies are focused on things like clothing and cosmetics; they aren’t things that would be classed as necessities.