If properly used, these apps and services can be excellent tools. However, if employees aren’t budgeting carefully, they can end up spending more than they planned, learn dangerous financial habits, and even end up in debt.
Although the goalposts are always moving, sometimes the divide between what’s considered modern vs. outdated can be fairly clear cut. There are times in which modernization improves our lives; after all, I can’t be the only one happy that I don’t have to use a VHS rewinder any more, and no longer have to trek out to Blockbuster in the snow to get a movie, now that Netflix is available.
However, there are some more worrying trends that are beginning to appear, and the disappearance of layaway in favor of “buy now pay later” programs is something I find concerning. Some employees have likely already reexamined their budgets due to changes in the economy, while others have yet to do so. For many, especially after difficult years during which many lost their jobs and had to face significant financial cutbacks, spending on extras or presents may have turned into a process that will have to be spread out over time.
In the past, one might put items on layaway at the store, placing a deposit to reserve a purchase and then following a payment plan until the balance is paid and they receive that item. However, these programs are being replaced with “buy now pay later” plans, which are a similar conceptually and vastly different in execution and significantly more risk. Whereas the payment plan must be completed for the item to be received in layaway (working towards a future payoff), with “buy now pay later” customers receive the item and essentially go into debt. Not only should plan sponsors be concerned about the terrible financial habits such programs encourage, but they can also encourage overspending with disastrous results.
First, the obvious: The immediate item-in-hand satisfaction without having paid in full can be dangerous and lead to overspending in its own right, because it was so cheap and easy (in the moment) to acquire something. This is a habit that can bleed over into more expensive and dangerous territory like home ownership, disincentivize price comparison, and lead those who aren’t carefully budgeting to overspend on smaller purchases that add up. However, in addition to these bad habits, the “buy now pay later” model is broadly based on loans, meaning that customers may be on the hook for interest and/or late fees in addition to the principal balance. And because consumers have already had the item in hand the entire time they’ve been paying back the loan, they may not be able to return it.
Take Affirm, for example. A lending company with loans made by Cross River Bank, Celtic Bank, and Affirm Loan Services, LLC., their model is built on interest-based payment plans. They allow users to choose the length of time over which they want to repay their loan. While it’s true that they don’t have the same late fees that users may find elsewhere, interest rates can be astoundingly high. According to their website, “Your rate will be 0% APR or 10–30% APR based on credit, and is subject to an eligibility check.” For reference, according to data provided by the Federal Reserve, the average APR across all credit card accounts for the third quarter of 2021 was 14.54%. While credit cards may have associated fees, it’s very possible that they’d be less than the fee-less interest rate Affirm charges.
Klarna is a similar service using a different business model in which users can take advantage of their interest-free “pay later” plans that allow them to pay in four installments (spaced every two weeks), within 30 days, or later by card. However, if borrowers wait too long to make an overdue payment, their terms state that “A Late Fee of up to $7 may be charged if any scheduled payment remains unpaid after 10 days (this will never exceed 25% of your Installment Payment amount)”. However, their monthly financing options do come with an Annual Percentage Rate (APR) of up to 24.99% which frankly may still be more reasonable than Affirm.
These are just two of many options out there, but the possible pitfalls of the “buy now pay later” model are well-illustrated therein. Now is an excellent time for Plan Sponsors to draw their employees’ attentions to the ways in which, if properly used, these apps and services can be excellent tools. However, if employees aren’t budgeting carefully, they can end up spending more than they planned, learn dangerous financial habits, and even end up in debt.
These articles are prepared for general purposes and are not intended to provide advice or encourage specific behavior. Before taking any action, Advisors and Plan Sponsors should consult with their compliance, finance and legal teams.
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