The Rise of Buy Now, Pay Later: A Concerning Trend for Generation Z

Bloomberg Opinion — As Generation Z entered adulthood, studies emerged claiming they were the generation with the lowest levels of credit card debt. Of course they were: They couldn’t easily access credit cards.

The Credit Card Accountability and Disclosure (CARD) Act of 2009 made it significantly more difficult for college-age consumers to obtain a credit card. Gone are the days when banks prowled college campuses offering to discharge 18-year-old students in exchange for a cooler, a Frisbee, or a backpack. Today, you have to be at least 21 years old or prove that you have independent income or a guarantee.

The new rules helped keep young adults out of consumer debt, at least for a few years. Only recently is Generation Z’s use of credit cards starting to catch up with other generations. But even before credit card usage increased, a new contender arrived. Buy now, pay later services like Klarna and Affirm Holdings have lured Generation Z into consumer debt in the same way that credit cards did with millennials and Generation X. Unfortunately, not yet. There are laws that protect young people who buy now and pay later from getting into financial trouble. And buy now, pay later options don’t have the benefit of helping young adults build credit when they use cards responsibly.

There are variations between services, but most offer consumers the ability to split their purchase into four interest-free installments. It’s a new version of layaway, except buyers receive their items immediately. You can easily end up with multiple loans through a variety of lenders with different due dates, a situation that creates a much more complicated debt ecosystem than having a credit card or two.

Although “buy now, pay later” plans do not usually charge interest, there may be fees for non-payment or late payments. Buyers can also end up overdrawing their checking accounts if they set up automatic payments and the funds aren’t there. Additionally, your credit history may be damaged if payments are significantly late or if the loan goes into default and is turned over to a collection agency.

Another cause for concern is that a disproportionate number of Buy Now, Pay Later users are considered “financially fragile,” according to recent research by the Federal Reserve Bank of New York, meaning they would have difficulty obtaining US $2,000 the following month for an emergency. Nearly a third of buy now, pay later users have a bad credit score, have been delinquent on a loan in the past 12 months, or have been denied a credit card.

Users of these services are more likely than average to earn between $20,001 and $50,000, according to a report from the Consumer Financial Protection Bureau. These consumers also lack access to other types of loans. 32% had personal loans and 33% had student loans, according to the CFPB report. More than two-thirds had revolving credit card debt.

Access to installment financing to buy online at the age of 18 seems worrying to me. Over the years I’ve heard countless stories of people who went into credit card debt in their late teens and early 20s, largely due to easy credit coupled with minimal understanding of how these financial tools worked. The Credit Card Act helped reduce some of the easy access and keep consumers informed of the risks by requiring card issuers to disclose the interest and fees that users would owe if they only made the minimum monthly payment.

In late 2021, the CFPB opened an investigation into buy now, pay later services, but it has yet to result in meaningful regulations or an evolution of industry practices. Changes are long overdue. The ideal would be to raise the minimum age necessary to use a “buy now, pay later” service to 21 years and limit the number of loans that a person can have at the same time in all credit institutions.

Credit cards are not without their flaws, such as the incredibly high interest they charge on revolving debts. But in many ways they are still my preference over repeated uses of buy now, pay later services. It may sound strange that an author and personal finance expert would extol the virtues of credit cards for a young person. After all, credit cards lure many people into debt, especially with sign-up bonuses and rewards programs. But they also have significant advantages.

Aside from strong fraud detection and protection compared to buy now, pay later, credit cards are more beneficial for building credit. Credit cards share your payment information with credit agencies, which in turn provide information to credit rating companies. Healthy credit card behavior (typically making on-time payments and using 30% or less of your available credit limit) can help anyone build a strong credit history and score. Especially in these inflationary times, few people can buy high-value items, such as cars, houses, or a college education, in cash. A good credit score helps keep your interest rate more affordable, which I guess is a pretty relative term right now.

There are people for whom buying now and paying later makes sense. Being able to stretch the cost of a purchase over four installments at a time of life when costs would otherwise be high, such as during a move or preparing to have a child, could make cash flow more manageable without incurring debt. But that seems like a well-thought-out financial move and not the whims of people who simply want something when they want it.

The ease with which anyone, but especially young consumers with little financial experience, can access buy now, pay later services is alarming. These services are stepping in to extend credit to people who would otherwise likely be turned down for lines of credit. Without new regulations in the sector, young adults must learn to navigate the modern financial world and understand the potential pitfalls of accessing credit and loans.

This note does not necessarily reflect the opinion of the editorial board or of Bloomberg LP and its owners.