The use of ‘buy now, pay later’ is growing. Labeled “the hottest product” in the United States during the 2021 holiday season, the buy now, pay later market is projected to reach about half a trillion dollars by 2026.

Companies offer buy now, pay later (BNPL) to attract consumers with limited cash by delaying repayment at no interest, making it easier for them to buy products they couldn’t otherwise afford. These payment plans also help retailers attract consumers who like their products but might not have the liquidity to purchase them. But buyers incur some costs in using these plans — for example, consumers might run into difficulties in repaying BNPL loans, and sometimes they face processing delays and disputes over refunds, when they try to return products. 

In a paper published in the journal Quantitative Marketing and Economics, Preyas Desai, the Spencer R. Hassell Professor of marketing at Duke University’s Fuqua School of Business and Professor Pranav Jindal of the Indian School of Business examined companies’ incentives in adopting BNPL plans as well as the role of the consumers’ costs of using BNPL.

How Buy Now/Pay Later works

With buy now, pay later, retailers allow consumers to pay for products in deferred, interest-free installments, “typically three payments spread over six weeks,” the authors write.

Access to BNPL is easier than to other forms of consumer credit, as providers usually don’t perform a credit check of buyers, or only run a soft credit inquiry, making it more accessible than credit cards, Desai said.

This also means BNPL doesn’t affect the buyer’s credit score, and while reaching your credit limit can get your credit card declined, there are virtually no spending limits for anyone who uses a buy now/pay later plan, the authors write.

Third-party loan providers

Retailers typically partner with third-party financial companies to provide BNPL plans, because offering consumer credit “is an extremely complex process subject to extensive regulations,” the researchers write.

The loan provider bears the risk of default on the plan and is compensated by the retailer with fees between 2-8% of the product price, higher than the usual 2-3% fee on credit card purchases — despite the risk for BNPL loan providers being lower than that of a credit card because, the researchers write, the credit is tied to only one product.

BNPL expands companies’ market

The researchers analyzed the incentives for retailers, both in a monopolistic and competitive environment and found that companies offer buy now/pay later plans to expand their market. While a monopoly always gains by offering BNPL, “our research found that in a competitive market, with high-end retailers and low-end retailers, sometimes only low-end retailers will offer BNPL, because they actually have a lot more to gain,” Desai said.

“The conventional wisdom is that firms that offer a higher quality, more expensive product will benefit most from offering BNPL,” Desai said. “But we found it can be the other way around.”

Sometimes “mixed strategies” may be more useful for retailers, the authors found, with companies offering BNPL for some of their products but not for others.

But if some firms always have an advantage in offering BNPL, the utility of these plans for the whole society needs to include the costs borne by consumers, the researchers write.

The costs of buy now pay later

This relatively easy form of credit may enable consumers to buy products they can’t afford, the researchers say, but this may come with unanticipated costs, such as late-payment fees and default.

One issue is that even though buy now/pay later is a form of consumer credit, until recently BNPL consumers haven’t enjoyed the same level of protection as credit card users, in the case of returns and disputes, Desai said.

In fact, disputes are complicated, the authors point out, and may even extend past the loan terms.

“If you order something with a credit card and the product is broken, you return it with no problem,” Desai said. “But if I order something with BNPL and it arrives broken, maybe I'll get my money back, but maybe I will get into some complicated situations because there are multiple parties involved — even though nobody intends to do anything incorrectly.”

The Consumer Financial Protection Bureau (CFPB) found that in 2021, 13.7% of all BNPL loans were either returned or disputed, and consumers received an average of 60.3% of refunds. “BNPL borrowers,” CFPB reported, “exhibit measures of financial distress (...) significantly higher than non users.”

Although these costs are seen as consumers’ costs, Desai and Jindal show that they pose a problem for the sellers as well. The reason is that if savvy  consumers are aware of these costs, the appeal of BNPL to them is reduced. As a result, sellers are not able to attract as many consumers with BNPL.

“Even if all consumers fully understand all the costs of using BNPL, such costs will always deter some of them from buying the product and, as a consequence, also hurting retailers and BNPL providers,” Desai said.

Industry observers sometimes also worry that consumers might not fully understand or anticipate the costs of using BNPL, Desai said. In such cases, the availability of BNPL can lead consumers to make “suboptimal choices,” such as buying more expensive products or products they wouldn’t otherwise buy, due to their financial circumstances, the researchers noted.

Furthermore, consumers don’t realize that BNPL can lead to higher overall prices.

“Whenever there is more consumer demand, companies will generally charge a higher price,” Desai said. “The firm that offers BNPL charges a higher price because it now has increased demand. And if my competitor charges a higher price, I can also charge a higher price, even if I don’t offer BNPL. It’s a sort of spillover effect."

New rules for buy now, pay later

In May 2024, the Consumer Financial Protection Bureau announced a new rule classifying BNPL lenders as “credit card providers.” As a consequence, in disputes with retailers, BNPL consumers will now have the same protection as they have with credit cards.

“The CFBP’s announcement is an important step in the right direction,” Desai said, because the new protection will reduce the costs of buy now/pay later and also increase the consumer awareness around them — this way avoiding the “underestimated” costs of the deferred payments.

“Reducing the costs of buy now/pay later is a win-win outcome because it will make BNPL more attractive to consumers, and at the same time more profitable for retailers and BNPL providers,” he said.

At the same time, adding more transparency about the real costs “is a good thing” for the society as a whole, he said.

“It's important, as a society, that consumers are fully educated to make their decisions. Information and protection, those are the two desired outcomes.”