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Cracking Down on Buy Now, Pay Later Loopholes

Cracking Down on Buy Now, Pay Later Loopholes - The Wild West of BNPL

The explosive growth of buy now, pay later (BNPL) services has rapidly outpaced efforts to regulate the industry. With BNPL usage surging, particularly among younger consumers, regulators are scrambling to rein in risky lending practices. The "Wild West" atmosphere has allowed BNPL companies to aggressively market their services while largely avoiding consumer protection laws.

BNPL services entice consumers with the promise of interest-free installment plans for online purchases. However, hidden fees and penalties often lead to spiraling debt burdens. A recent Consumer Financial Protection Bureau report found 1 in 5 BNPL users incur late fees, with the average late fee around $7 per transaction. These extra costs add up, especially for lower income borrowers.

Despite billing themselves as risk-free financing, BNPL loans enable consumers to take on more debt than they can reasonably afford. One study found nearly 40% of BNPL users regret their purchases, suggesting excessive and impulse spending. With limited underwriting, BNPL companies advance credit to borrowers who may already be financially strained.

Compared to credit cards, BNPL loans receive minimal scrutiny. They sidestep lending regulations which require assessing a borrower's ability to repay. The speed and ease of BNPL approvals circumvent the cautionary pause of a credit card application.

BNPL services also avoid standard credit reporting. This means on-time payments are not reported to help a user's credit score. But missed payments hurt scores without any offsetting benefit. Shut out from credit building, BNPL borrowers can get trapped relying on subprime lenders.

The BNPL "debt loop" ensnares the most economically vulnerable. Low-income households and younger borrowers are more likely to lean on BNPL financing. Facing job losses or income volatility, these borrowers can ill afford extra interest and fees. Nevertheless, BNPL companies spend billions on targeted ads to enroll new users.

Cracking Down on Buy Now, Pay Later Loopholes - Regulating Deferred Interest Loans

Deferred interest loans allow consumers to make purchases without paying interest for a set promotional period, typically 6-24 months. While these financing offers seem attractive, deferred interest loans enable consumers to easily overextend themselves. Borrowers are lured in by low “teaser” rates, only to face high retroactive interest if the balance is not fully paid on time.

Over 90 million Americans have deferred interest loans, predominantly store credit cards. Limits often exceed $10,000, resulting in large potential interest obligations. One study found borrowers with deferred interest loans owed an average of $2,500 in retroactive interest. Failure to pay off balances frequently triggers over 20% interest accrual.

Regulators have sounded alarms about the risks of deferred interest lending. The Consumer Financial Protection Bureau reported more complaints about store cards than nearly any other financial product. Their analysis found deferred interest billing practices are unclear and misleading. Key terms are buried in fine print, confusing customers.

The CFPB has called for strengthening regulation to ensure affordability assessments and improve transparency. All costs and conditions should be disclosed upfront in easy-to-understand language. Lenders should also provide advance warnings as the no-interest period nears expiration. For high-risk loans, lenders could be required to verify income and existing obligations.

At the state level, legislators have moved to rein in deferred interest abuses. In 2020, California enacted protections capping deferred interest rates and limiting loan amounts based on income. New York recently proposed requiring credit checks and preventing retroactive interest above 25%.

Cracking Down on Buy Now, Pay Later Loopholes - Reining in Repeat Offenders

Predatory lenders frequently target vulnerable groups like military families, immigrants, and the elderly. Repeat borrowing from high-cost lenders creates a debt trap many cannot escape. Regulators must rein in lenders who chronically ensnare customers in abusive loan terms.

Active duty servicemembers are enticing marks for unscrupulous lenders. Frequent relocations make it hard to build credit or wealth. The stress of deployments causes many to seek quick cash without reading the fine print. A 2006 Department of Defense report found predatory loans were impairing military readiness. In response, Congress passed the Military Lending Act to protect armed forces personnel. The MLA caps interest rates and prohibits lenders from requiring servicemembers to resolve disputes in arbitration.

While the MLA was a start, loopholes remain. Lenders skirt the law by claiming affiliation with Native American tribes not subject to state usury laws. Online lead generators feed borrower data to lenders masking as tribal entities. These tactics allow predatory lenders to operate through regulatory cracks. Strengthening and enforcing the MLA is essential to safeguard those sacrificing to serve our country.

Payday lenders are repeat offenders known for trapping borrowers in cycles of rollover loans. With fees up to $30 per $100 borrowed, the cost to repeatedly extend payday loans soars to over 400% APR. Borrowers like Ella, a single mother in South Carolina, get stuck paying $150 monthly to repeatedly renew a $400 payday loan. The average payday borrower takes out 10 loans a year, paying fees equating to triple the original loan amount.

Cracking Down on Buy Now, Pay Later Loopholes - Transparency in Billing and Payment Practices

A lack of transparency in billing and payment practices allows predatory lenders to mislead borrowers. Hidden fees, convoluted terms, and purposefully confusing disclosures let unscrupulous lenders take advantage of unwitting consumers. Regulators must mandate simplified, standardized billing statements to shine a light on opaque lending practices.

Lisa, a teacher and single mother in Phoenix, took out a $300 payday loan when her car broke down. Due to undisclosed fees, the actual finance charge was over $90 for the 2 week loan. However, the lender buried this cost in tiny print as a vague “documentation fee.” Lisa believed she would pay $15 for the loan as advertised. But when her account was debited $105 two weeks later, Lisa realized the true cost was 360% APR.

A federal report on payday lending found fewer than one in five borrowers realized how expensive the loans were. Lenders exploit information gaps by hiding costs in vague fees instead of interest rates. Without seeing a clear totals for amount borrowed, fees, interest, and payment due, borrowers cannot make informed choices.

While payday lenders are the biggest offenders, credit cards also utilize complexity to overcharge customers. Issuers lure consumers with teaser rates as low as 0%, then retroactively charge deferred interest from the original purchase date if balances are not paid off completely. Major issuers have faced lawsuits over unclear deferred interest billing. Customers reasonably assumed teaser rate purchases would not accrue interest during the promo period.

Regulators must establish guardrails for transparent billing disclosures. Statements should display total interest paid to date, itemized fees, and a summary section with key loan terms and costs. Visual tools like tables and charts can help illustrate total costs. Easily comparable metrics like annual percentage rates must be prominently featured.

Cracking Down on Buy Now, Pay Later Loopholes - Standardizing Late Fees and Penalties

Predatory lenders rely on astronomical late fees and penalties to generate profits. Lack of standardization allows them to impose punitive costs on borrowers who miss payments. While reasonable late fees help offset collection costs, excessive charges become their own profit center. Standardizing permissible late fees would prevent lenders from using them to take advantage of cash-strapped borrowers.

A 2019 survey found the average late fee for credit cards was $30. However, some issuers charge up to $40 for a single late payment. These near-extortionate penalties disproportionately affect lower-income borrowers. Those struggling to cover monthly expenses can be pushed into delinquency and default by a single unexpected cost.

Lisa, a part-time barista in Oklahoma City, used a credit card to pay a $2500 emergency room bill. Between rent, car payments, and childcare for her 5-year-old, she had no savings cushion. When an illness caused Lisa to miss two days of work, she paid her card 18 days after the due date, triggering a $35 late fee. She then paid another $35 fee the next month, starting a downward spiral. Within 6 months, late fees and rising interest rates increased Lisa's balance by over $1000.

While credit cards are the most common source of late fees, other predatory products also rely on them. Payday lenders frequently charge $20-30 for each payment missed. With triple-digit interest rates, repeatedly rolling over loans results in late fees dwarfing the original loan amount. Title lenders also impose monstrous penalties, averaging $50 per month according to a Pew Charitable Trusts study. These escalating fees make repayment practically impossible.

Regulators should implement a federal cap on late fees based on the size of the outstanding balance. Smaller loans warrant lower capped fees scaled to the account balance. For example, a credit card with a $500 balance could have a maximum late fee of $15. Cards with $2000 balances could be capped at $25. Indexing permissible fees to balances would ensure affordability.

Late fee caps need teeth to deter abuse. New Mexico enacted a fee limit of $15 or 5% of payment amounts, whichever is less. But a lack of enforcement led many lenders to ignore the cap. New York State's late fee law imposed mandatory license revocation for violations. This accountability motivated lenders to follow the rules. Penalties like revoking lending licenses can offset economic incentives to flout fee limits.

Cracking Down on Buy Now, Pay Later Loopholes - Protecting Vulnerable Borrowers

Predatory lenders frequently target the most vulnerable members of society. The elderly, military families, immigrants, and low-income households are more susceptible to abusive lending tactics. Regulators must take extra steps to shield these communities from exploitation.

Senior citizens often rely on fixed incomes from Social Security and pensions. With limited funds, they can be tempted by advertisements for easy cash. One study found seniors account for nearly 25% of payday loan borrowers. Failure to repay such predatory loans can threaten their financial stability. Lenders encourage seniors to take out new loans to pay off old ones. These endless debt cycles drain scarce retirement savings.

The Consumer Financial Protection Bureau found the median payday loan fee for seniors was $89 per two weeks – over three times higher than the $22 median fee for younger borrowers. Seniors paid $2.6 billion in fees alone over 11 years. These burdensome costs push vulnerable older Americans closer to insolvency.

Immigrant communities also face language and cultural barriers that predatory lenders exploit. New arrivals often lack credit histories or familiarity with the US financial system. Seeking loans near immigration hubs, lenders peddle misleading offers and obscure expensive terms in the fine print. Abuses include extorting interest rates over 100% and intimidating borrowers who fall behind. Fearful of consequences from unpaid debts, undocumented immigrants are especially reluctant to report abuses.

Single parents strive to provide stable homes for their children despite limited resources. When unexpected expenses arise, payday loans can seem like their only option. However, these predatory loans create cycles of debt that destabilize families. Researchers found single parents were three times more likely to use payday loans than the general population. Their precarious finances leave little margin for error. Unaffordable loans put food, housing, and other necessities at risk.

Cracking Down on Buy Now, Pay Later Loopholes - BNPL Companies Skirting Credit Reporting Rules

A glaring loophole allows BNPL companies to avoid reporting both positive and negative payment information to credit bureaus. This opacity locks borrowers out of credit building while exposing them to score damage from missed payments. BNPL account data needs to be integrated into standard credit reporting.

On-time BNPL payments can help consumers establish credit histories and improve scores. However, most BNPL firms do not report this activity to Equifax, Experian and TransUnion. This prevents borrowers from reaping rewards for responsible usage.

Ella, a recent college grad in Denver, used Afterpay and Affirm to build her wardrobe for starting her new job. Over a year, she made dozens of on-time BNPL payments. But lacking reporting, Ella’s credit score barely budged. With “thin file” reports, lenders saw her as high-risk. When Ella applied for an auto loan, she got rejected for not having enough credit history.

While positive payment data goes unreported, missed BNPL payments do get referred to collection agencies that can crater credit scores. This imbalance unfairly penalizes consumers. BNPL borrowers gain no advantage from on-time payments but face all the downsides of delinquencies.

James, a waiter in Atlanta, fell behind on a few BNPL payments after his restaurant closed temporarily during the pandemic. These missed payments showed up on his credit report, even though previous on-time payments did not. Within months, James’ credit score dropped 100 points. His damaged credit shut off access to affordable car loans and apartments.

BNPL usage is soaring, especially among young first-time borrowers. For example, Afterpay users doubled in 2020. With BNPL relied on as a credit on-ramp, lack of reporting locks out borrowers from accessing better mainstream credit. Critics say opaque reporting policies are designed to keep borrowers dependent on BNPL services.

In contrast, traditional credit cards always report both positive and negative data. This full transparency allows borrowers to earn improved scores and access more affordable credit. Aligning reporting standards is critical as BNPL displaces other forms of consumer credit.

Cracking Down on Buy Now, Pay Later Loopholes - Closing Escape Hatches in Consumer Protection Laws

Predatory lenders exploit loopholes and ambiguities in consumer protection laws to peddle abusive financial products with impunity. Strengthening state and federal regulations to close these escape hatches is essential to shield vulnerable communities.

A glaring loophole allows payday lenders using so-called “rent-a-bank” schemes to circumvent state interest rate caps. The lender partners with an out-of-state bank immune to local usury laws due to federal preemption rights. The bank nominally issues the loan, while the payday lender markets and services it. Although 18 states ban payday loans, rent-a-bank partnerships allow lenders to operate while charging exorbitant rates.

Lisa, a home health aide in rural Iowa, took out a $400 loan marketed as convenient, short-term help. However, the fine print revealed a 175% APR and auto-renewing clauses locking borrowers into repeated rollover fees. Within 5 months, Lisa paid over $1000 in interest and fees on the original $400 debt. Iowa banned such predatory loans in 2009, but the out-of-state bank tie-up skirted state protections.

Another tactic lenders use is claiming affiliation with Native American tribes not subject to state regulations or lawsuits. Online lead generators sell customer data to lenders that use tribal sovereignty to shield operations. Loans of $500-1500 can carry 350% APRs and terms making them virtually impossible to repay before repeated rollover fees multiply the initial amount.

Brenda, a teacher in California, borrowed $1000 to fix her car but soon owed over $6000 due to interest and fees exceeding 300%. When she tried contesting the terms, her loan agreement mandated arbitration on tribal land 1000 miles away. The lender's supposed tie to a tribe made it impossible to seek recourse despite California's interest rate cap.