What the new regulations mean for the pay later industry

Increased arrears in repayment of consumer loans

The latest data from the Federal Reserve Bank of New York reveals a disturbing trend in credit card delinquencies, especially among young adults. Collectively, Americans owe an estimated $1.12 trillion in credit card debt, with 8.9% of credit card balances past due over the past year. However, a more significant problem is the emergence of approximately $46 billion in “phantom debt” generated by Buy Now, Pay Later (BNPL) schemes, which is a major factor in rising crime rates.

Industry leaders have been concerned about phantom debt for some time and have been advocating for tighter regulation. These significant risks, largely resulting from BNPL transactions, often go unreported, placing a significant but unnoticed financial burden on consumers. This hidden debt makes it easier for consumers to make purchases without fully understanding the consequences, especially as many young consumers do not realize that BNPL contracts mean new debt or do not understand their impact on their future financial well-being. Automatic withdrawals by BNPL providers from consumers’ bank accounts or debit cards can deplete funds needed for other financial obligations such as credit card payments, leading to higher crime rates.

In an economy characterized by rising inflation and interest rates, financial pressures are mounting. The current economic climate has prompted banks to tighten lending criteria, which deepens the challenges facing consumers. As mortgage rates skyrocket – recently hitting 7% as 10-year Treasury yields continue to rise – disparities in borrowing costs based on credit score and geographic location are widening, further complicating the financial landscape. With one in seven Gen Z consumers already maxing out their credit cards, the need for better financial literacy and stronger consumer protections is greater than ever.

A regulatory response to the BNPL industry

In response to these challenges, the Consumer Financial Protection Bureau (CFPB) has issued a new interpretive rule. This rule redefines BNPL lenders as comparable to credit card providers. The aim is to extend similar protections to consumers, provide better management of BNPL operations and align with traditional credit card industry standards.

Here are three takeaways from the CFPB’s new rule:

1. Explaining BNPL as Credit: The CFPB classifies BNPL services similarly to traditional credit card offerings, aligning them with a similar regulatory framework.
2. Consumer rights regarding disputes and refunds: Consumers have the right to dispute charges and seek a refund for returned products or canceled services, similar to a credit card transaction.
3. Obligations for BNPL lenders: BNPL providers must now thoroughly investigate disputes and stop collecting any payments during this period. They are also required to provide users with periodic billing statements, which increases transparency and accountability.

As the market evolves, credit card-linked installment plans are becoming more popular for large purchases. They provide a safer and more sustainable way to spread payments, particularly attractive to higher-income consumers who want to buy more with the 0% installments associated with the card. These plans take advantage of existing lines of credit issued by card issuers, which avoids the need to take out new loans and reduces the risk of additional debt at very high APRs.

The combination of credit card debt and BNPL phantom debt is putting significant pressure on vulnerable Gen Z consumers. Regulatory actions by agencies such as the CFPB and the transition to more transparent card-linked installments are critical in steering the future of consumer credit towards greater stability and trust. As this industry evolves, it is important that all interested parties understand the nuances of the different types of loans and their impact on your personal financial situation.