Buy Now, Pay Later

By: 
Al Jacobs

If you will voyage with me to an earlier day, you will receive an education in early to mid-20th century economics. As your first lesson, the $1.75 you will pay for a full meal in your local Chinese restaurant will be paid in cash – probably with a twenty-five cent silver coin added as a tip. And if the whole family goes to an upscale steak house, where the bill may approach the lavish price of $10, the bill will again be paid in U.S. currency. Generally, restaurants do not accept personal checks.

With your shopping performed at Montgomery Ward or Sears & Roebuck, be prepared to pay either by cash or personal check. As an alternative, you may take advantage of their easy payment plans, where these firms will finance your purchases at truly reasonable interest rates. If, however, it is furniture you’re in need of, an independent furniture store is where you’ll most likely go. Presuming your living room sofa is priced at $200, the payment method you will possibly use is $50 down followed by three equal monthly installments of the same amount – there will be no interest charge of any sort.

At this point, you may be wondering when you will be inclined to use either your credit or debit cards. Sorry, but we are still a generation away from acquiring these devices. Except for individual firms such as oil companies and hotel chains, which began issuing them in the 1920s, the first universal credit card, introduced by the Diner’s Club, Inc., did not exist until 1950. What we now regard as modern monetary practices, embraced by the vast majority of twenty-first century Americans, were mostly unheard of a couple of generations ago. Whether or not we are better off because, as a society, we now employ these contemporary techniques is a matter we shall explore.

Let us start our investigation at ground zero. The first true general-purpose credit card, known as BankAmericard, was introduced in 1958 by the Bank of America. Although initially made of paper, it quickly became plastic. With its $300 spending limit, cardholders could carry balances month-to-month for a fee and the unpaid balance need not be repaid monthly. By 1966 a number of prominent banks formed the Interbank Card Association and Mastercard came into existence. Since then, of course, the use of credit cards are universal; they are now as prevalent as driver’s licenses.

You cannot deny that possession of a financial artifice which enables you to purchase an item you desire, when you do not possess the funds available to pay for it, constitutes an enviable convenience. And at the end of the month, when the invoice arrives and you make the payment in full with no additional charge of any sort, you will be pleased by the way the modern world of finance arranged the system.

As our time machine just returned us to the present, I’ll take this opportunity to inform you that, according to the Federal Reserve, as we entered 2020, Americans owed $1.09 trillion in credit card debt. You might also note, in 2019 our nation’s consumers paid banks $121 billion in credit card interest. As to how we are handling this credit, a report released by Wilbert Van Der Klaauw, senior vice president at the New York Fed, reveals delinquencies among credit card borrowers steadily rose since 2016, with the youngest Americans, aged 18 to 29, suffering the highest delinquency rates of 9.36%.

In searching for an explanation as to why our society is not faring well in the credit card environment it resides in, you must understand the firms controlling this market are not in the charity business. Their setting of interest rates for persons who do not regularly pay their full card balances will be as high as they can get away with.

As recently as July 8, 2021, the latest available data reveals the average annual credit card interest rate to be 20.26%. Incidentally, for you credit card holders, you might care to see what rate you will be charged if you fail to pay your full balance at the end of the month. The figure will be found on each monthly statement you receive. I just checked my Chase Visa Card report and on purchases and balance transfers I pay 22.99%. If you regard this as an appalling figure, you are beginning to understand the problem. Unbelievably, there are millions of persons who willingly permit their accounts to be so charged; perhaps this is what the modern generation considers as acceptable.

While we are wallowing about in twenty-first century lending practices, we must not ignore one of the more insidious operations I’ve yet seen. It is a practice known as payday lending. They’re called payday loans because payday is typically when borrowers pay them back. They’re offered as small, short-term loans which can tide the borrower over in an emergency. The interest rates, on an annualized basis, can be in the neighborhood of 300% – much higher than even the most expensive credit cards.

According to a recent Pew survey, some 12 million Americans – roughly 1 in 20 adults – take out a payday loan in a given year. They tend to be relatively young and earn less than $40,000 annually; generally they lack even a high school diploma. The rate of borrowing is highest among minorities. From the data we’ve seen, payday loans are concentrated in those communities, and African-American and Latino borrowers are disproportionately represented among the borrowing population.

In summary, the vast majority of payday loan borrowers use these loans to handle everyday basic expenses which don’t go away in two weeks, like their rent, their utilities and their groceries. Even worse, borrowers are offered no choice but to roll over their loans again and again, jacking up the refinancing fees. In fact, rollovers are an essential part of the industry’s business model. Simply stated, payday loans are structured as a debt trap by design. Were I this nation’s emperor, I would decree that no borrower may ever be charged more than 12% per annum, under any circumstance.

We shall now examine one of the more recent contrivances being used to encourage citizens to shop. It is an increasingly popular buy now – pay later method known as a credit app – somewhat similar to what I described as the way a furniture store disposed of a sofa in the prior century. Very simply, there are firms whose online ads urge shoppers to stores and online sites where they may purchase items with down payments of only one-fourth of the purchase prices. They offer an interest-free line of credit, with the balance to be paid in three separate installments over a six-week interval, with no additional fees or charges.

As you might guess, this marketing scheme is designed to attract young shoppers with little or no established credit. Like with credit cards, these firms charge the merchants a fee on each transaction, usually 2% to 8% of the purchase price. In most cases the purchaser is not charged anything, although one company – Quadpay – adds what they call a platform fee of one dollar for each installment payment. Otherwise, buyers appear to be making their purchases at no additional costs of any sort. Accordingly, you may say this is nothing but a win – win for the purchasers … yes, this is what you may say.

Let’s now take a closer look at a few details of this credit app program. My first concern relates to the price of what is being purchased. As the marketer is preselected by the credit app firm and the interest-free payment deferral is a primary selling consideration, I question whether the purchaser is receiving a truly competitive price. Maybe they are; maybe they are not. Secondly, if one or more of the installment payments is not paid on time, there will be late charges. And with subsequent delinquencies, the charges multiply and credit ratings rapidly decline.

However, the most profound detriment is the inducement this buy now – pay later program has on persons with no established sound financial habits. As one young woman remarked: “It’s kind of nice to be able to say, ‘Oh, you know, I can’t afford to buy this right upfront, but I can split it up into four payments and afford it that way.’” Before the apps she normally spent weeks saving money for special acquisitions. The apps allow her to get products immediately. As she then remarked: “Why not just buy it?” This may explain why one of the credit firms, Credit Karma, found about 38% of their customers missed one or more payments.

These apps are becoming massively employed, and firms such as Macy’s and H&M are partnering with the services now soaring in popularity during this COVID-19 pandemic. The millennials and Generation Z consumers are attracted by the ability to bypass traditional credit cards and still delay payments with no interest.  Roughly 42% of Americans report using the apps at least once.

A final thought: I admit to having been raised in an environment where borrowing was viewed with suspicion and purchases were traditionally conducted in a method referred to as full price, cash on the barrelhead. I’m convinced this contributed to my prosperity. And I’ve never forgotten the advice of a wealthy old gentleman who, many years ago, advised me: “Interest is not something you pay; it is something you collect.”

Al Jacobs, a professional investor for nearly a half-century, issues weekly financial articles in which he shares his financial knowledge and experience. Al may be contacted at al@abjacobs.com

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