Americans are notoriously indebted, with skyrocketing credit card balances stealing headlines while inflation eats away at paychecks. But there is a new kid in the financial bloc.

The so-called “buy now, pay later” (BNPL) industry is taking the United States by storm. The number of Americans who have used the credit model, which is very popular in Australia, has increased by 300% every year since 2018, according to Bloomberg.

BNPL companies like Afterpay, Klarna and Affirm claim the model financially locks in people who cannot access traditional forms of credit.

However, consumer advocates argue that the model is under-regulated and poses risks for consumers.

“It’s actually a way for consumers to unknowingly accumulate a lot of debt in a short period of time,” said Elyse Hicks, consumer policy adviser at Americans for Financial Reform.

If the sector continues to grow, it could push a generation of younger Americans into a debt trap.

The rise of BNPL in the US

While the various companies in the sector may differ slightly, BNPL services allow a consumer to pay for an item or service in four interest-free installments over a period of time, typically two weeks. Already ubiquitous online, BNPL is now rolling out in stores.

While BNPL gained momentum ahead of COVID-19, a pandemic-driven shift in consumer spending towards e-commerce and retail goods fueled sector growth. BNPL purchases have increased by 230% since the beginning of 2020, according to a study commissioned by Afterpay by IT services and consulting firm Accenture.

Usage estimates vary, but similar studies show that one-third to one-half of Americans have used BNPL services. The sector has penetrated the younger population more than any other.

Several technology and financial services companies are also jumping on board. In June, Apple became the latest major player to announce its own BNPL service.

Buy (more) now, pay later (not).

For consumers, companies like Klarna and Affirm often present their interest-free, installment-based lending services as a liberation from the credit card industry and other predatory lenders.

But users, especially young ones, are already getting into debt. The reasons are both psychological and regulatory.

Consumer advocates stress how consumers’ ability to buy products in installments seems to push people to buy more – and more than they can afford.

Consumers interpret split payments as cheaper and therefore tend to abandon their shopping cart less and make more purchases. Because of this, merchants are indeed willing to pay BNPL service provider fees ranging from 2% to 8%, which is more than credit card company fees.

According to Hicks, the promise of affordability of BNPL services is illusory. “It’s costing consumers a lot more money than it probably would have if they just used their credit card,” she told DW.

Many users miss payments – and regret their purchases. According to Credit Karma, almost 40% of BNPL users say they missed at least one payment.

BNPL services generally don’t charge interest like credit cards, but they do charge fees or other penalties if users miss a payment. Late payments can even trigger overdraft fees on a buyer’s bank account.

Young people seem to be the most vulnerable

Private finance and investment advisory firm Motley Fool found that nearly 50% of young people using BNPL made a late payment or incurred a late fee – the most of any age group.

Unlike credit cards, it can be difficult to track exactly what is owed. If users take out multiple BNPL loans at once, they can quickly find themselves in trouble.

In general, many consumers seem confused by BNPL. A survey found that about a third of BNPL users do not understand the service well.

Chemareea Biggs is a person who fell into a debt trap after stacking BNPL loans. After losing several jobs during the pandemic, she was unable to repay Affirm’s “pay-in-four” loan for plane tickets, triggering a debt spiral.

She told Bloomberg that the situation went downhill after missing a payment.

Younger generations in the US are already saddled with record levels of debt

Same service, different rules

Part of the reason consumer debt traps are even possible is that BNPL services are largely unregulated.

Consumers enjoy numerous protections against traditional lenders such as credit card companies under the Truth in Lending Act (TILA). But BNPL lenders can bypass TILA because the law only covers loans that are split into five or more payments. BNPL briefly stops at a four-payment split.

Hicks told DW, “A lot of the buy-now-pay-later companies don’t want that to be considered a loan. Because if it’s considered a loan or a line of credit, then it fits one of the regulations.”

Bypassing TILA means BNPL companies have less legal responsibility to ensure users can repay the loan. Some services may do mild credit checks on large items, but for the most part, no-questions-asked credit is given.

While certain BNPL services may ban users until their debts are paid off, these consumers are not prevented from borrowing from other BNPL entities.

BNPL companies showcase the ease with which consumers can leverage their products as financial inclusion for those excluded from traditional credit.

Critics argue that BNPL services, like credit cards, should be regulated

Act as credit cards, treat like credit cards

But according to a study by American consumer credit agency TransUnion, BNPL users actually have more credit cards, debit cards, personal loans or other lending products than the “general credit-active population”.

Meanwhile, another study found that almost a fifth of BNPL customers only used the service after maxing out their credit card.

Taylor Roberson, federal policy adviser at the consumer advocacy group Center for Responsible Lending, told DW, “One of the most positive aspects of the product has to do with the potential for consumers who pay on time to have that payment history positively noted on their credit reports.” And that’s perhaps where the benefits end.”

Roberson explained that consumers are not currently rewarded by rating agencies for paying BNPL loans on time, partly because these lenders are not required to report their details like other lenders.

But even if BNPL companies choose to report their data, users may find that their credit score has been compromised if they missed a payment.

Roberson and other consumer advocates believe one solution is for BNPL to be regulated by TILA and overseen by the Consumer Financial Protection Bureau (CFPB). In fact, the CFPB launched an inquiry into the industry late last year and the findings are expected to inform consumer groups about the future.

“These are basically credit cards within the meaning of the laws and regulations. As such, we think they should be regulated as such,” Roberson concluded.

Edited by: Uwe Hessler