Is Klarna safe, and what does the rise of ‘buy now, pay later’ mean for online shopping?

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Stacy Nick
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Whether they’re buying a trendy new outfit or groceries, Americans shopping online are increasingly presented with the option to “buy now, pay later.” Online retailers partner with services such as Klarna, Afterpay or Affirm to offer buyers the option to pay in installments, typically without interest if repaid on time.

As the holiday shopping season approaches, Colorado State University’s College of Business marketing department’s Jon Zhang and the finance and real estate department’s Hilla Skiba discuss the impact these installment plans have on retailers — and on consumers.

The number of e-commerce websites offering ‘buy now, pay later’ services at checkout seems to have exploded in recent years. Why might that be? Why would a company be interested in working with a service such as Klarna, Afterpay or Affirm?

Zhang: This is not that different from when the credit card was introduced. These novel payment formats are removing consumers — potential customers of these products — farther and farther away from cash. But the benefit, from a retailer perspective, is that it lowers the friction. It increases conversion, because you don’t need to pay. It’s the same psychological mechanism, I would imagine, with paying with a credit card instead of paying with cash. There’s a pain of opening your wallet and pulling it out, whereas with a credit card, there’s this temporal removal of the separation of when I get to enjoy the product — which is today or tomorrow, if it’s overnight shipping — but then, this decoupling of enjoyment from payment, which is down the road. That’s very appealing to many consumers, so they have no problem buying now and paying later. From a retailer perspective, it’s very beneficial.

Skiba: There’s a lot of research in psychology showing that we spend more when we use a credit card versus cash — it’s what Jon was saying about the pain of giving up cash. We’re much more considerate of how much we should spend if it’s cash versus credit. There’s this mental accounting and different budgets we have in our brain. It’s very interesting.

Zhang: The reason why there’s such an explosion of “buy now, pay later” is the barrier of getting approved by these providers — Klarna, Afterpay and Affirm — is a soft pull on credit. In other words, even someone who couldn’t qualify for a traditional credit card is still likely to get approved through these payment providers. That suddenly opens up a bigger pool of shoppers. You might have someone who does not have a credit card — either because of poor credit or no credit or they’re young consumers — now, they can buy, because they don’t need a credit card anymore. That’s a boon for retailers in terms of higher conversion, just higher revenue. Because the risk of non-payment is assumed by these finance platforms, the retailers carry no risk of non-payment, so that’s also good — just like retailers carry no risk when the customer doesn’t pay the credit card. It’s the same idea.

This more inclusive access to credit opens up the possibility of more people buying more things online, which in principle is a good thing, right? Financial inclusivity and broader access to credit should be a good thing. But the problem is, just like when we have problems with credit cards, that people overspend.

How might this trend influence customer habits — and retailer strategies?

Zhang: If you don’t accept credit cards, it’s hard to do business. I would imagine more retailers and more brands will adopt these platforms. I can only see them gaining popularity in the coming years, and that will become the norm. It’s still a bit of a novelty today, just like a credit card was a novelty 30-40 years ago, but I would imagine this will be the norm in a few years. That’s the competitive landscape. From a consumer perspective, again, people are just going to get used to it. The competitor will be credit card companies — credit card companies will probably offer their own similar platforms, where they give you a soft credit pull and they don’t need to qualify for a credit card. Or Visa, Mastercard, Amex might buy these guys to round out their portfolio. From a consumer perspective, I think, again, you’re going to have a lot more younger people overspend, which is good for our aggregate demand, the economy, but creates problems from an individual financial planning perspective.

Why might consumers choose to take on these kinds of loans over using a credit card?

Skiba: I went to Best Buy and found a range finder for $300, and I actually qualified myself for a loan with Zip yesterday. Because I had plugged in my credit card information, I was automatically qualified for the loan, then I read through the terms on the loan. And actually, from the finance perspective, I was expecting to see massive interest rates, but from the time value of money perspective — which me, as a finance person, I’d be interested in — there is no interest on these loans.

How does Klarna work?

Skiba: If the purchase is $320 and you pay it over the following four months, it’s $80 per month, so from a pure finance perspective, it actually is a good deal. I could see myself actually using this kind of a service. It financially makes sense when there’s no interest. But overall, I like to use my credit card. I get my points; I get my cash back. You don’t have any of that available with this kind of “buy now, pay later” loan.

I also looked at the size of these loans. They’re also very small, so my guess is it’s going to be mainly the customers who do not qualify for a credit card who would then be willing to take on these sorts of loans.

Is there any risk to consumers when it comes to taking on these loans for a variety of relatively small purchases? What should consumers know before they buy?

Skiba: This $320 loan that I didn’t proceed with had a $7 late penalty per month — that ended up being about 8% — is still less than you would get if you had a credit card and missed the payment. So, from the pure finance perspective, this is a better deal than using a credit card, but then they also had the origination fee on the loan. If they have a higher risk customer, I assume that the origination fee is going to be more than zero. I’m also assuming that many people who are willing to go this route probably don’t necessarily read the fine print very carefully. What Jon said, though, is true that a credit check is not part of the process, it seems — or if they do a credit check, it’s going to be very soft in nature. But if you do miss the payments, it will affect your credit score in the future.

This is where you have to be financially savvy to make sure that you don’t overspend and don’t over commit to borrowing what you can’t pay back. Because it is very easy to get these loans, it can end up being a real problem if you have not done your finances carefully and planned ahead. If you fail to pay the loan, it will affect your credit score.

Some researchers have referred to ‘buy now, pay later’ loans as ‘phantom debt’ because they aren’t necessarily reported to credit bureaus. What impact could a rise in this sort of debt have? Could it prevent younger Americans from building a credit history?

Skiba: You’re in control of your own finances, and it’s just something that is the responsibility of the buyer or the consumer to make sure that they can pay back the debt. So, “phantom debt”? Yeah, it won’t show up yet in those credit reports. But again, it can hurt you if you don’t make those payments. Could it prevent younger Americans from building a credit history? Yes, perhaps this is something to consider. But there’s other ways to build credit history besides using credit cards.

Thinking about who the competition is going to be for these companies, it’s going to be the credit card firms, Visa and Mastercard. Maybe it will also make that landscape a little more competitive because the APRs that credit card companies are charging are outrageously large. Are we going to start seeing a little more reasonable rates on credit card debt? Probably not, but I had a very negative view on “buy now, pay later” before I started digging deeper into it, and now I’m not that negative. I just hate seeing certain demographics being taken advantage of with this instant gratification type of purchase. What I thought I would find predatory practices, I didn’t — it doesn’t come across that way.

How could the rise of ‘buy now, pay later’ loans shape our economy?

Skiba: The market is still quite small — I’m just going based on Fortune’s article that in 2023, the market for these loans was about $30 billion — but it is expected to grow rapidly. I’m seeing expected annual growth rates in this market in excess of 20% per year. It is expected to explode, and again, financially, based on just the pure time value of money, this kind of loan is actually not a bad thing as long as it’s paid off when it’s supposed to be paid off and you don’t take on the late fees and especially that your credit score doesn’t take a hit.