By Bill M. Petti
Global Legal Law Firm
Buy now, pay later (BNPL) allows consumers to make purchases online over a series of installments. Innovated in Australia, this method of payment blew up during the pandemic, during which time consumers shifted almost primarily to online shopping. But what is BNPL, exactly? BNPL is a form of credit that allows a consumer to split a retail transaction into smaller, interest-free installments and repay over time. Simply put, BNPL is a type of installment loan.
BNPL is most commonly offered as a pay-in-four plan. Say, for example, that a consumer purchases a $400 shirt from an online retailer: if the consumer exercises this installment plan, then the consumer will pay $100 at checkout and the remainder in varying intervals.
The typical BNPL structure divides a purchase, which could range from $50 to $1,000, into four equal installments, with the first installment paid as a down payment due at checkout, and the next three due in two-week intervals over six weeks.
The largest BNPL partners are Affirm, Afterpay, Klarna, PayPal and Zip. These providers offer consumers POS financing, typically issued at 0 percent interest. Commonly, consumers are required to pay back these loans within four payments over two months. Providers like Affirm, Klarna, and PayPal also offer longer-term, interest-bearing loans that may be described as BNPL loans by companies that market them, but these financing options have interest rates which can stretch up to 36 percent.
According to McKinsey & Co.’s 2021 study on POS financing, metrics demonstrate that BNPL will continue to accelerate in 2023 (see www.mckinsey.com/industries/financial-services/our-insights/buy-now-pay-later-five-business-models-to-compete). Average annual transactions per account were much larger for BNPL than for consumer purchases using private-label credit cards.
Due to increased BNPL customer engagement, even the largest merchants that initially declined to offer BNPL products are now integrating these payment options at checkout. Offering BNPL options can be a very profitable tool for merchants. However, there are a number of potential consumer risks associated with BNPL products. What is more, there are also risks to merchants and banks.
The BNPL industry is less transparent than legacy credit products. The lack of transparency stems from the relatively sparse information available to the public and the lack of BNPL loan repayment standards to address furnishing to the Nationwide Consumer Reporting Companies. Conversely, once the consumer enters into a BNPL installment payment program, they are usually provided with limited disclosures about the terms and fees associated with the installment loan. The longer-term, interest-bearing loans similarly lack transparency and uniformity regarding the repayment terms and interest, which results in confusion among consumers.
Often, BNPL products are approved for consumer-borrowers who have credit scores below 700. Because borrowers habitually use BNPL products and lack the means to timely repay the installments, they frequently default on their repayment obligations. When a borrower does not make these payments, many BNPL providers charge late fees, often around $7 per missed payment on an average loan size of $135.
Chargebacks are unlikely to affect the merchant directly because most BNPL offerings are structured such that the consumer pays the BNPL provider, not the merchant. Still, many BNPL providers will pass the cost for chargebacks on to the merchant. Merchants should consult sophisticated counsel to review each BNPL provider’s policies prior to entering into such BNPL partnerships. Merchants are nonetheless responsible for consumer-initiated refunds. For instance, PayPal’s BNPL policy requires the merchant to refund the PayPal Pay in 4 loan amount due, in full or partial, toward the total balance.
Merchants must be prepared to bear the cost of refunding all or some of the BNPL loan amount as purchases are returned for refunds. Moreover, anti-money laundering compliance controls are necessary for merchants to account for potential friendly fraud and account takeover and the liability for such activities.
In addition—and aside from the risks of chargebacks, refunds and consumer defaults—BNPL is also the subject of emerging regulatory oversight. On Sept. 15, 2022, the Consumer Financial Protection Bureau issued a report on BNPL market trends and the resulting consumer impacts (see www.consumerfinance.gov/about-us/newsroom/cfpb-study-details-the-rapid-growth-of-buy-now-pay-later-lending). The CFPB is the federal administrative agency that has enforcement and rulemaking authority over the credit industry and BNPL providers.
In its report, the CFPB found, among other things, that many BNPL lenders have shifted toward the app-driven “lead generation” acquisition model. Lead generation is one of the primary methods through which certain brands receive high-traffic app placements. Through lead-generation fees—which the CFPB describes as “essentially a form of disguised advertising”—merchants pay affiliate fees to the lender for each purchase that originated from the preferred brand placement. This adjustment has the potential for the most far-reaching consumer impact, as it strengthens the breadth and depth of the lender’s relationship with the borrower, and thus increases the likelihood of habitual BNPL usage.
There has been a 300 percent increase in the number of consumers who have taken out a BNPL loan since 2018. With such an increase in usage comes an increase in risks attributable to underdeveloped consumer protection, leading to predatory practices. For example, providers offering these products may opine that they are not required to provide consumers with the same disclosures of interest and fees and are not subject to the same dispute resolution protections or return/refund procedures as other credit products. Some providers even claim that their products are not loans or credit products at all, but instead refer to them as payment plans.
The CFPB also raised concerns regarding late fees and transactional fees, which the lenders collect from consumers, as well as inconsistent BNPL furnishing standards. While the CFPB limited its review to nonbank tech companies offering BNPL, BNPL providers will need to adequately prepare for increased regulatory oversight and supervisory examinations to come.
As BNPL practices accelerate in 2023, merchants will need to consider offering BNPL options to compete in the competitive, ever-changing consumer market. Correspondingly, BNPL providers and banks will also need to assess required capabilities, compliance and risk, consumer experience, vertical focus, competitiveness of offering, and other factors. BNPL providers, merchants and banks must evolve and understand their compliance requirements in the complex regulatory landscape. 
Bill M. Petti is a post-bar law clerk at Global Legal Law Firm. Bill graduated cum laude from California Western School of Law with four American Jurisprudence awards. Prior to joining Global, he clerked for the United States Attorney’s Office in both the Affirmative Civil Enforcement Division and Civil Litigation Division. Bill also interned for the United States Securities and Exchange Commission during his second year of law school and assisted with several high-profile investment adviser examinations. He passed the July 2022 California Bar Examination on his first attempt, but is still pending approval for swearing in. Once he is sworn in, Bill will join Global Legal Law Firm as an associate. Contact Global at :info@attorneygl.com.
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