In line with our risk management framework, today we published our Q4 2019 performance update.
Are there risks to buy now, pay later?
It’s no exaggeration to say that the global financial system as a whole is predicated on the ability to buy something now, and pay for it later. Barely anyone would be able to make a substantial purchase such as a house without an instrument like a mortgage. Banks lend to each other in vast amounts, underpinned by money markets. And global trade would break down instantly in the absence of the liquidity provided by borrowing.
It therefore follows that this concept plays an important role at consumer level too, permeating into sectors such as UK retail, which accounted for £380bn in sales in 2018. Indeed, much as you may read about the struggles of retailers and the UK high street, the fact is that this sector remains one of Britain’s powerhouses.
The past decade has been a particularly trying one for UK retailers, but one development which has given a whole range of sectors a shot in the arm is the rise to prominence of retail finance. Such credit facilities come in a number of forms, and among the more popular varieties are so-called ‘buy now, pay later’ deals.
What is buy now, pay later and what are the benefits?
Many UK retailers have been seeking innovative ways of offering credit to minimise the hurdle for customers of the initial price tag, and buy now, pay later (BNPL) schemes have thus become commonplace. Essentially, as the name suggests, this form of credit enables customers to defer the payment of goods or services they purchase for an agreed period of time - usually up to 12 months.
There is no set structure to BNPL credit, but these deals tend to involve some sort of interest-free window. If the customer clears the balance owed before this 0 per cent period - often referred to as the 'pay later date' - comes to an end, then they should not incur any cost of credit. Payment(s) can usually be made either as a lump sum, or via instalments, depending on the terms of the arrangement.
Enabling customers to buy something now and worry about the cost at a later date isn't about encouraging reckless spending. On the contrary, consider the case where someone's boiler or washing machine breaks down. This is a household essential, but, rather than having to go down the cumbersome route of traditional finance options, which invariably take days or weeks, the customer is able to replace such an appliance almost instantly without needing to have upfront savings to cover the cost.
For the retailer, there are clear benefits too. Invariably, BNPL agreements will be conducted via a lender, which means they not only convert a customer who might not otherwise have completed the purchase - they also receive the payment upfront.
As for the lender, margins tend to be small within BNPL, and it is sometimes considered to be a loss leader. However, it does give them the opportunity to expand their credit offering into new marketplaces, which both unlocks new types of customers and diversifies their credit portfolio.
What charges are associated with buy now, pay later?
If the cost of the purchase has not been fully paid once the pay later date arrives, then you will be required to make at least a minimum monthly repayment thereafter, which will be inclusive of interest and fees that begin to kick in. In many cases, interest charges will also be backdated to include the interest-free period (ie: retrospectively commencing from the date the purchase was made). There are usually significant penalties for any missed payments after the promotional offer comes to an end too.
The APRs which apply once the 0 per cent period ends tend to vary considerably, depending on the retailer. However, as a rule of thumb, it is reasonable to expect this to be somewhere between 19.9 per cent and 34.9 per cent.
Alternatively, rather than charging interest with a set APR, some retailers will impose a monthly fee - either a fixed amount, or a percentage of the outstanding balance. Or another option may be that the customer is charged a settlement fee if they clear their balance after the pay later date. Usually this will act as a substitute for interest and/or other fees, but in some cases, it could be a supplementary charge.
So is buy now, pay later risky?
As with any form of lending, there are risks associated with BNPL in that it can put undue financial pressure on the customer over time (or bring about risk of default to the lender). A better question to ask is whether these risks are more significant than, say, those associated with taking out a personal loan or credit card.
Again, the answer depends somewhat on the specific deal in place, the cost of credit and the payment terms. It also very much depends on the level of affordability of customers who are approved, their understanding of how this type of debt is structured, and also the level of transparency among lenders in displaying this information.
It is the responsibility of the customer to ensure they read the fine print, and that they fully understand the terms of the agreement. They also need to factor in the possibility that their financial circumstances could change in the future, and have complete clarity on the implications if they do not clear their balance within the promotional period. But, equally, it is incumbent upon the retailer and/or lender to ensure that they uphold reasonable standards of credit modelling and underwriting with regard to this type of finance, and that they clearly communicate the details of the offer.
One risk that comes with the territory for lenders is fraud, and in the case of BNPL, one of the biggest threats is identity theft. This risk isn't exclusive to the lender though, and can be immensely damaging to the reputation of the retailer too. It once again underscores the importance of robust credit models, and having the necessary safeguards and technologies in place to protect against fraudulent activity.
Do Brits understand buy now, pay later?
Interestingly, the Financial Ombudsman Service has seen a growing number of complaints relating to so-called 'catalogue shopping' in recent years, which includes BNPL. As a result, the FCA have encapsulated this into a review of 'catalogue debt'; the consultation for which ended in March, with the final rules set to be released in June.
What is a bit more concerning is the lack of wider understanding of cost of credit in general among UK consumers; in particular, those of a younger age. A 2018 study by Arrow Global compared the collective grasp of the concept of an APR among all UK adults versus those between the ages of 18 to 24. Perhaps disconcertingly, Arrow found that nearly a third of those in the latter category do not even know what the term means.
Especially for millennials, who tend to lack the disposable income of their older counterparts, the temptation of a convenient payment solution at checkout which defers payment seems reasonable. However, in the absence of a sound understanding of the payment terms and potential costs, it is clear to see how difficulties could arise.
Is buy now, pay later a force for good?
If used sensibly, the answer, categorically, is yes. BNPL deals have been at the heart of the recent growth in digital payments, and provide a convenient option at the point of checkout. Particularly with regard to online shopping, which now accounts for nearly 20 per cent of total retail spend, it has helped breathe life into the ailing retail sector as a result of making the cost of big-ticket items more affordable. For retailer and customer, this represents a true win-win, and it is therefore no surprise to see an increasing number of retailers signing up to this service.
But, as with any type of credit, it is not right for everyone, and great care should be taken on the part of the customer to ensure that it is a good fit. For example, if you have the money to hand, you could still opt for a BNPL deal, and keep your savings in a high-interest account for the duration of the 0 per cent period, and then simply pay the balance at the time of the pay later date.
Or even if you don’t have the money to hand at the time of purchase, but are confident you will have it before the pay later date, then BNPL is a rational option, as it will effectively amount to interest-free credit.
However, if such circumstances do not reflect your current situation, or you are unsure what your short-term financial future holds, you may want to consider alternatives such as personal loans, a purchase credit card offering 0 per cent interest for a fixed period of time, or other options within the realm of retail finance. Or, if these are unlikely to yield a cost-effective solution either, it may just be that you need to defer the purchase itself until a later date.
Certainly, BNPL has an important role to play within UK financial services; principally in the context of reviving our famous high streets. But it is also correct that the rise of such credit facilities is matched by an appropriate level of regulation, a commitment to transparency on the part of retailer and lender, and also a continued drive to educate consumers as to the advantages and disadvantages of this finance option. If this balance can be struck, then BNPL has the power to bring about significant, sustainable economic benefits.
Our website offers information about saving, investing, tax and other financial matters, but not personal advice. If you're not sure whether peer-to-peer lending is right for you, please seek independent financial advice, and if you decide to invest with Lending Works, please read our Key Lender Information PDF first.
Since opening our doors back in 2014, we’ve always prided ourselves on living and breathing two key principles at Lending Works: innovation, and putting the customer first in everything we do.
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