Too good to be true? The rise of buy now, pay later

If Apple sees value in something, then it's often a sign of significant growth to come. This is what happened in July when the US gadget giant said it was working on a service to let shoppers pay for purchases in instalments, as it makes a move into the rapidly growing "buy now, pay later" market.

And just last week, Square, the payments firm of Twitter co-founder Jack Dorsey, announced it would purchase buy now, pay later pioneer Afterpay Ltd for $29 billion (€24.4 billion) in what was the biggest deal yet for Square and a record buyout of an Australian business.

The buy now, pay later market has rocketed over the past few years, as shoppers eschew traditional credit cards in favour of the buy now, pay later option, which is neatly aligned with online shopping trends.

In Ireland, the market is still largely in its infancy, but with the imminent arrival of one of the world's largest players, in the shape of Swedish giant Klarna, not to mind the potential offered by Apple and Square in due course, it's likely to grow substantially.

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But what is it, how does it work, and is it good or bad for consumers?

What is buy now, pay later?

As the name suggests, if you agree to buy a product on a buy now, pay later basis, you’ll “buy” it now, make a part payment, and complete the transaction at a fixed time in the future. Typically, if you abide by the terms of the arrangement, you won’t have to pay any interest on your “borrowings”.

A little like a personal contract plan (PCP) on new cars, the big attraction of buy now, pay later is that it makes something immediately more affordable. This is because you won’t see the withdrawal for the full amount from your bank account as you pull out of the forecourt/ecommerce site.

The current big player in the market Klarna, which was recently valued at some $45.6 billion. And it's coming to Ireland

Buy now, pay later firms lend shoppers instant funds, typically up to a few thousand euro, which can be paid off interest-free. As they generally make money from merchant commission and late fees – and not interest payments – they sidestep the legal definition of credit and therefore credit laws.

That means providers are not required to run background checks on new accounts, unlike credit card companies, and normally request just an applicant’s name, address and birth date. Critics say that makes the system an easier fraud target.

How big is the market?

Here in Ireland, the market is set for rapid growth. A report from research group Research and Markets published in mid-July found that the Irish market is expected to grow by about 50 per cent every year to reach about $1.2 billion (€1 billion) by 2028. It’s currently worth about $267 million, but is expected to hit more than $400 million this year.

Humm is one of the main providers of the financing tool in Ireland at present. Formerly known as Flexifi Europe, a subsidiary of the Australian consumer financial services group, Humm offers buy now, pay later services for hundreds of retailers and service providers across the State – everyone from Harvey Norman to Midland Carpets, Dental Options Dublin, Ebikes Ireland, Bonavox Hearing Specialists, Brereton Jewellers, Audi centre, Weir & Sons, Benetton, and Homebase.

Paypal also offers a buy now, pay later option but, according to a spokeswoman, it is currently only available in the US, the UK, France, Germany and Australia, and is "not yet" available in Ireland.

However, the current big player in the market Klarna, which was recently valued at some $45.6 billion. And it’s coming to Ireland.

Back in 2016, the Swedish giant, which is licensed as a bank in Sweden, notified the Irish Central Bank that it intended on carrying out activities in Ireland on a cross-border basis. However, it has since concentrated on other markets and doesn't currently offer such services in Ireland.

But it has recently commenced hiring for its Irish arm, as it starts to create a presence for an Irish launch.

It’s understood that a move will happen here but is unlikely to launch before next year, as the payments service has just launched in France and has another few markets to get off the ground before it will focus on Ireland.

Who uses it?

While buy now, pay later is a technique that may have come to prominence to spread the cost of buying couches or washing machines, it is now used predominantly by younger women to buy clothes and shoes.

A report from the Woolard Review, commissioned by the UK's Financial Conduct Authority, found that about 25 per cent of users are aged 18 to 24, with 50 per cent aged 25 to 36. Three quarters are female, and 90 per cent of transactions are for clothes and shoes.

Let's say you buy a €50 dress on boohoo.com with the Swedish operator. You'll pay a third of the cost up front, with another third scheduled for 30 days later

The reason for this perhaps is how it meshes so well with online shopping; younger shoppers will often buy more clothes than they will ultimately end up keeping. But by opting for the buy now, pay later option, they only have to pay a third of the costs up-front, so won’t have to wait for those refunds to hit your account should you send a lot back.

How does it work?

Paypal describes it as being “like a credit card without the plastic”, and to an extent, it works like this.

So, instead of paying upfront for a new pair of jeans, for example, customers will click on the “buy now, pay later” button in the checkout section of a website, which means that they will be able to split their payments over a longer period of time, typically three or so payments every few weeks to avoid interest, or across several months if they’d prefer, though this will carry an interest charge.

Consider Klarna. Let’s say you buy a €50 dress on boohoo.com with the Swedish operator. You’ll pay a third of the cost up front (€16.66), with another third scheduled for 30 days later. That will be automatically deducted from your credit or debit card, and the same with a third payment 60 days after the initial purchase. No interest will apply to these payments, which means that the total cost to you is the same as if you had paid it up-front.

You can also opt for the “financing” option, which allows you to spread out payments over a longer period of time – from about six to 36 months – but this involves a credit check.

The actual cost depends on the retailer but Klarna has a maximum charge of 18.9 per cent. So, for example, a €100 purchase will mean payments of €34.39 each month for three months. The financing cost means that the total cost will be €103.17 to the buyer.

If used in a certain way, it's considerably cheaper than buying with a credit card and making only the minimum balance

With Humm, for “little things” – classified as worth €500 or less – you can repay in five fortnightly or three monthly payment slices at no cost. Its “big things” offering allows you to spend up to €30,000 and repay over six years, with certain retailers, including the aforementioned.

For example, at Harvey Norman, if you spend more than €1,000, you can spread the cost over 24 months; but there is a cost for this. A €40 application fee applies, as well as a €3.50 monthly account fee (so an additional €84 over two years). While no interest applies on the first year, an APR of 5.45 per cent kicks in for the second.

The pros

The Financial Times recently described the technique as a “clever innovation”, as it allows you to smooth out your bills over a few weeks or months without paying high interest charges on credit and store cards.

And if used in a certain way, it’s considerably cheaper than buying with a credit card and making only the minimum balance. For example, with Klarna, if you repay the dress in full after 60 days, it won’t cost you anything extra, which compares favourably with a credit card with an APR of 20 per cent.

This is because, with credit cards, it is consumers who carry the cost of interest; with buy now, pay later however, it is the retailers who swallow the charges.

Of course, one assumes this cost of credit will then be passed on, at least partially, to consumers in higher charges for goods and services. No such thing as a free lunch and all that.

At a broader level, when buy now, pay later takes off in a market, it could mean that even those who pay up-front and in full for goods and services can start to pay more, as they’re subsidising the cost of credit for others.

The cons

While it may undoubtedly be a cheaper form of financing than your flexible friend, the experience of young shoppers in other countries show that it can lead to financial problems.

Firstly, it can encourage you to spend more than you would have otherwise. This is what Klarna tells retailers as part of its sales pitch to get them to sign up, noting that “retailers typically see a 68 per cent increase in average order value with Klarna Instalments”. It also claims that 44 per cent of shoppers would have abandoned their online purchases if a pay later option wasn’t available.

Does this mean that those 44 per cent of shoppers couldn’t really afford what they would have liked to buy?

If you find that you can't pay once the free payment period expires, your debt may be referred to a debt collection agency

It also raises the risk of building up interest bills, as if you opt for the "financing" option with Klarna for example, you'll face a hefty APR of up to 18.9 per cent, while with Littlewoods, a rate of up to 43.7 per cent can apply, which carries a "high cost" credit warning and requires the group to register with the Central Bank alongside moneylenders.

Not only that, but you could find yourself still paying back the cost of a T-shirt or dress after a year, or a washing machine after two years, which may not be the best use of your money, and may inhibit other financial goals you may have.

If you find that you can’t pay once the free payment period expires, your debt may be referred to a debt collection agency, while if you borrow money over a longer period of time, your bad debt may be referred to a credit agency which can affect your credit going forward.

Is the sector authorised?

At the moment, the Central Bank has a limited role in regulating such service providers. Not all buy now, pay later providers may have to be authorised, depending on the type of credit services they offer.

Moreover, not all such lending arrangements have to be notified to the Central Credit Register, operated by the Central Bank, only those where the amount is for €500 or more.

This will likely change once the Retail Credit and Credit Servicing Firms Bill 2021 is enacted, probably in the autumn. The legislation, as it stands, will extend the regulator’s authorisation and regulatory remit to buy now, pay later operators.

According to a spokeswoman, such firms will then fall within the full authorisation and regulatory remit of the Central Bank, and allow the Central Bank to apply the Consumer Protection Code 2012 (and any other relevant code, or any relevant regulation) to such credit providers and servicers.

The UK regulatory authority, the Financial Conduct Authority, is also making moves to bring such operators under its regulatory guidance. – Additional reporting Reuters/Bloomberg