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Americans May Be Taking on Too Much Pay Later ‘Phantom Debt’

“Buy Now, Pay Later” loans are helping to fuel a record-setting holiday shopping season. Economists worry they could also be masking and exacerbating cracks in Americans’ financial well-being.

The loans, which allow consumers to pay for purchases in installments, often interest-free, have soared in popularity because of high prices and interest rates. Retailers have used them to attract customers and to get people to spend more.

But such loans may be encouraging younger and lower-income Americans to take on too much debt, according to consumer groups and some lawmakers. And because such loans aren’t routinely reported to credit bureaus or captured in public data, they could also represent a hidden source of risk to the financial system.

“The more I dig into it, the more concerned I am,” said Tim Quinlan, a Wells Fargo economist who recently published a report that described pay-later loans as “phantom debt.”

Traditional measures of consumer credit indicate that U.S. household finances overall are relatively healthy. But, Mr. Quinlan said, “if those are missing the fastest-growing piece of the market, then those reassurances aren’t worth a darn.”

Estimates of the size of this market vary widely. Mr. Quinlan thinks that spending through pay-later options was about $46 billion this year. That is relatively small when compared with the more than $3 trillion that Americans put on their credit cards last year.

But such loans — offered by companies like Klarna, Affirm, Afterpay and PayPal — have climbed fast. This growth comes at a moment when the finances of some Americans are starting to show early signs of strain.

Credit card borrowing is at a record high in dollar terms — though not as a share of income — and delinquencies, though low by historical standards, are rising. That stress is especially evident among younger adults.

People in their 20s and 30s are by far the biggest users of pay-later loans, according to the Federal Reserve Bank of New York. That could be both a sign of financial problems — young people may be using pay-later loans after maxing out credit cards — and a cause of it by encouraging them to spend excessively.

Liz Cisneros, a 23-year-old college student in Chicago who works part time at Home Depot, said she was surprised by the ease of pay-later programs. During the pandemic, she saw influencers on TikTok promoting the loans and a friend said it helped her buy designer shoes.

Ms. Cisneros started using it to buy clothes, shoes and Sephora beauty products. She often had multiple loans at a time. She realized she was overspending when she didn’t have enough money while in a grocery checkout line. A pay-later company had withdrawn funds from her bank account that morning and she had lost track of her payment schedule.

“It’s easy when you keep continually clicking and clicking and clicking, and then it’s not,” she said, referring to when she realizes she has spent too much.

Ms. Cisneros said the problem was particularly intense around Christmas, and this year she was not shopping for the holiday so she could pay off her debts.

Pay-later loans became available in the United States years ago, but they took off during the pandemic when online shopping surged.

The products are somewhat similar to the layaway programs offered decades earlier by retailers. Online shoppers can choose from pay-later options at checkout or on the apps of pay-later companies. The loans are also available at some physical stores; Affirm said on Tuesday that it had started offering pay-later loans at the self-checkout counters at Walmart stores.

The most common loans require buyers to pay a quarter of the purchase price up front with the rest usually paid in three installments over six weeks. Such loans are typically interest-free though users sometimes end up owing fees. Pay-later companies make most of their money by charging fees to retailers.

Some lenders also offer interest-bearing loans with repayment terms that can last a few months to more than a year.

Pay-later companies say their products are better for borrowers than credit cards or payday loans. They say that by offering shorter loans, they can better assess borrowers’ ability to repay.

“We’re able to identify and extend credit to consumers who have the ability and willingness to repay above that of revolving credit accounts,” Michael Linford, Affirm’s chief financial officer, said in an interview.

In its most recent quarter, 2.4 percent of Affirm loans were delinquent by 30 days or longer, down from 2.7 percent a year earlier. Those numbers exclude its four-payment loans.

Briana Gordley, who works on consumer finance issues for a progressive policy organization, learned about pay later in college from friends, and still uses them occasionally for larger purchases.Credit…Montinique Monroe for The New York Times

The service makes the most sense for certain purchases, like buying an expensive sweater that will last many years, said the chief executive of Klarna, Sebastian Siemiatkowski.

He said that pay later probably make less sense for more frequent purchases like groceries, though Klarna and other companies do make their loans available at some grocery stores.

Mr. Siemiatkowski acknowledged that people could misuse his company’s loans.

“Obviously it’s still credit and so you’re going to find a subset of individuals who unfortunately are using it in not the way intended,” said Mr. Siemiatkowski, who founded Klarna in 2005. He said the company tried to identify those users and deny them loans or impose stricter terms on them.

Klarna, which is based in Stockholm, says its global default rates are less than 1 percent. In the United States, more than a third of customers repay loans early.

Kelsey Greco made her first pay-later purchase about four years ago to buy a mattress. Paying $1,200 in cash would have been difficult, and putting the purchase on a credit card seemed unwise. So she got a 12-month, interest-free loan from Affirm.

Since then, Ms. Greco, 30, has used Affirm regularly, including for a Dyson hair tool and car brakes. Some of the loans charged interest, but she said that even then she preferred this form of borrowing because it was clear how much she would pay and when.

“With a credit card, you can swipe it all day long and be like, ‘Wait, what did I just get myself into?’” Ms. Greco, a Denver resident, said. “Whereas with Affirm, it’s giving you these clear-cut numbers where you can see, ‘OK, this makes sense,’ or this doesn’t make sense.”

Ms. Greco, who was introduced to The Times by Affirm, said pay-later loans helped her avoid credit card debt, with which she previously had trouble.

But not all consumers use pay-later options carefully. A report from the Consumer Finance Protection Bureau this year found that nearly 43 percent of pay-later users had overdrawn a bank account in the previous 12 months, compared with 17 percent of nonusers.

“This is just a more vulnerable portion of the population,” said Ed deHaan, a researcher at Stanford University.

In a paper published last year, Mr. deHaan and three other scholars found that within a month of first using pay-later loans, people became more likely to experience overdrafts and to start accruing credit card late fees.

Financial advisers who work with low-income Americans say more clients are using pay-later loans.

Barbara L. Martinez, a financial counselor in Chicago who works at Heartland Alliance, a nonprofit group, said many of her clients used cash advances to cover pay-later loans. When paychecks arrive, they don’t have enough to cover bills, forcing them to turn to more pay-later loans.

“It is not that the product is bad,” she added, but “it can get out of control really fast and cause a lot of damage that could be prevented.”

Barbara L. Martinez, a financial counselor in Chicago who works with low-income families, meeting with a colleague about an upcoming workshop for people wanting to learn more about financial stability.Credit…Jamie Kelter Davis for The New York Times

Briana Gordley learned about pay-later products in college. She was working part time and couldn’t get approved for a credit card, but pay-later providers were eager to extend her credit. She started falling behind when her work hours were reduced. Eventually, family and friends helped her repay the debts.

Ms. Gordley, who testified about her experience last year in a listening session hosted by the Senate, now works on consumer finance issues for Texas Appleseed, a progressive policy organization. She said pay-later loans could be an important source of credit for communities that lacked access to traditional loans. She still uses them occasionally for larger purchases.

But she said companies and regulators needed to make sure that borrowers could afford the debt they were taking on. “If we’re going to create these products and build out these systems for people, we also just have to have some checks and balances in place.”

The Truth in Lending Act of 1968 requires credit card companies and other lenders to disclose interest rates and fees and provides borrowers with various protections, including the ability to dispute charges. But the act applies only to loans with more than four payment installments, effectively excluding many pay-later loans.

Many such loans also aren’t reported to credit agencies. As a result, consumers could have multiple loans with Klarna, Afterpay and Affirm without the companies knowing about the other debts.

“It’s a huge blind spot right now, and we all know that,” said Liz Pagel, a senior vice president at TransUnion who oversees the company’s consumer lending business.

TransUnion, other major credit bureaus as well as pay-later companies all say they are supportive of more reporting.

But there are practical hurdles. The credit-rating system rates borrowers more highly for having longer-term loans, including longstanding credit card accounts. Each pay-later purchase qualifies as a separate loan. As a result, those loans could lower the scores of borrowers even if they repay them in full and on time.

Ms. Pagel said that TransUnion had created a new reporting system for the loans. Other credit bureaus, such as Experian and Equifax, are doing the same.

Pay-later firms say they are reporting certain loans, particularly ones with longer terms. But most are not reporting and won’t commit to reporting loans with just four payments.

That worries economists who say that they are particularly concerned about how such loans will play out when the economy weakens and workers start losing their jobs.

Marco di Maggio, a Harvard Business School professor who has studied pay-later products, said when times were tough more people would use such loans for smaller expenses and get into trouble. “You only need one more shock to push people into default.”

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