As Gen Z aged into adulthood, studies emerged claiming they were the generation with the lowest levels of credit card debt. Well, of course they were: They couldn’t easily access credit cards.
The Credit Card Accountability Responsibility and Disclosure (CARD) Act of 2009 made it significantly harder for college-aged consumers to get a credit card. Gone were the days of banks hanging out on college campuses offering to sign up 18-year-old students in exchange for a cooler, frisbee or backpack. Today, you need to be at least 21 or demonstrate that you have independent income or have a co-signer.
The new rules did help keep young adults out of consumer debt, at least for a few years. It is only recently that Gen Z’s use of credit cards is beginning to catch up to other generations. But even before credit card usage increased, a new contender arrived. Buy now, pay later services such as Klarna and Affirm Holdings Inc. have lured Gen Z into consumer debt in the same way credit cards did with millennials and Gen Xers. Unfortunately, for now no laws protect young buy now, pay later users from getting in over their head financially. And buy now, pay later options don’t come with the perk of helping young adults build a credit history when they use the cards responsibly.
There are variations among services, but most offer consumers the ability to split their purchase into four interest-free instalments. It’s a new take on layaway, except that shoppers get their items immediately. You can easily end up with multiple loans across a variety of lenders with different due dates, a situation that creates a far more complicated ecosystem for debt than having a credit card or two.
While buy now, pay later plans typically don’t charge interest, there can be fees for missed or late payments. Shoppers could also end up overdrafting their checking accounts if they set up automated payments and the funds aren’t there. Plus, damage can be done to your credit history if payments are significantly late or the loan goes into default and is turned over to a collection agency.
An additional concern is that a disproportionate number of buy now, pay later users are considered “financially fragile,” according to recent research from the Federal Reserve Bank of New York, meaning they would have difficulty coming up with $2,000 in the next month for an emergency. Nearly one-third of buy now, pay later users either have poor credit scores, have been delinquent on a loan payment within the last 12 months or have been rejected for a credit card.
Users of these services are more likely than average to earn between $20,001 to $50,000, according to a report from the Consumer Financial Protection Bureau. These consumers also aren’t without access to other types of loans. Some 32% had personal loans and 33% had a student loan, according to the CFPB report. More than two-thirds had revolving credit card debt.
Access to instalment payment financing for online shopping at 18 is worrisome to me. I’ve heard countless stories over the years of people who fell into credit card debt in their late teens and early 20s in large part due to easy credit coupled with a minimal understanding of how these financial tools worked. The Credit CARD Act helped reduce some of the easy access and kept consumers informed of risks by requiring card issuers to state the interest and fees users would owe by only making the minimum monthly payment.
The CFPB did open an inquiry into buy now, pay later services in late 2021, but it has yet to amount to significant regulations or an evolution in industry practices. Changes are long overdue. Ideally, the minimum age needed to use a buy now, pay later service would be raised to 21 and a limit would be applied on how many loans across all lenders a person can have at any one time.
Credit cards aren’t without their faults, including the incredibly high interest they charge on revolving debt. But in many ways they are still my preference to repeated uses of buy now, pay later services. It might sound strange for a personal finance author and expert to extoll the virtues of credit cards for a young person. After all, credit cards lure plenty of people into debt — especially with sign-on bonuses and reward programmes. But there are significant advantages as well.
Aside from strong fraud detection and protection compared with buy now, pay later, credit cards are more beneficial for building credit. Credit cards share your payment data with credit bureaus, which in turn provide information to credit-scoring companies. Healthy credit card behaviour — generally, on-time payments and using 30% or less of an available credit limit — can help anyone build a strong credit history and score. Particularly in these inflationary times, few people can purchase big-ticket items like cars, homes or a college education outright in cash. A healthy credit score helps keep your interest rate more affordable — which I guess is a pretty relative term right now.
There are people for whom buy now, pay later makes sense. Being able to stretch out the cost of a purchase into four instalments in an otherwise high-cost season of life, such as during a move or preparing to have a child, could make cash flow more manageable without incurring debt. But that feels like a well-thought-out financial move and not the whims of people merely wanting something when they want it.
The ease with which anyone, but especially young consumers with limited financial experience, can get access to buy now, pay later services is alarming. The services are stepping in to provide credit to folks who otherwise are likely to get declined for lines of credit. Without new industry regulations, young adults need to learn how to navigate the modern financial world and understand the potential traps of access to credit and loans.
Credit: Bloomberg
Erin Lowry is a Bloomberg Opinion columnist. Views do not represent the stand of this publication
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