Jthere is no denying that the buy now pay later (BNPL) movement has been embraced by a large swath of the western world. According to data from C+R Research and Credit Karma, about half of all US consumers say they have used the store-provided installment loan option at least once. Indeed, many of these people have used a BNPL loan more than once, with furniture, electronics and clothing being some of the most common purchases for this crowd of borrowers.
The creation of this form of loan has proven to be a boon for Affirm Assets (NASDAQ: AFRM)which is not only one of the leading names in the industry, but largely shaped what the industry would become after its launch in 2013.
As the idea takes hold, its flaws begin to surface. Arguably, the micro-purchase lending industry could revert to what worked quite well before the BNPL madness took hold. This is good news for Synchrony Financial (NYSE: SYF)who tolerated this type of consumption fairly well.
Image source: Getty Images.
The same, but different
You may know Synchrony Financial better than you think. The company isn’t exactly consumer-oriented. But it’s the lender behind a group of retailers’ internal revolving credit companies. If you have a credit card issued by JC Penney, Lowe’sCitgo, Napa Auto Care or dozens of other retailers, you are actually a Synchrony customer.
Affirm’s model is similar, but not identical. Rather than maintaining a revolving credit account for an individual, Affirm makes it easier to purchase goods by extending time-limited installment loans — usually a total of four. Loans typically range from a few hundred dollars to $1,000, although they can be much higher. As is the case with Synchrony, the use of Affirm’s service incurs interest charges.
In the cases of Affirm and Synchrony, however, the lender works directly with a retailer, customer by customer.
An unregulated industry plagued by problems
One would think that consumers view and use the two similar borrowing options in an equally responsible manner. However, that would be a mistake. For reasons that aren’t entirely clear, many BNPL borrowers apparently have more trouble with their short-term loans than consumers with revolving credit accounts do with theirs.
A survey conducted last year by Credit Karma tells the story. Of the 44% of U.S. residents he says have exploited the buy now, pay later market for a loan, 34% of them had made at least one late payment. Of these 34%, 72% of them declare their credit ratings suffered Therefore.
If that were the only hint that many people don’t fully realize how quickly these microloans can become a burden, it could be dismissed. That’s not the only clue, though. A similar survey conducted by Morning Consult in January this year indicates that one in five adults in the United States who still owe a BNPL loan missed a payment that month. And, although not necessarily related, one in three borrowers also report having overdrawn a traditional bank account in the same month, roughly double the normal occurrence rate for overdrafts. Looking at the data from a different perspective, 2 in 5 BNPL US borrowers discovered a bank account in January.
Simply put, too many Americans have a money management problem that BNPL loans seem to exacerbate in a way that conventional revolving credit accounts do not. That’s why the Consumer Financial Protection Bureau (CFPB) launched a formal investigation into the entire industry, including Affirm, in December 2021.
There’s a time and a place for risk, but that’s not it
Nothing has yet come out of the CFPB investigation. And it is possible that nothing will.
With or without mandated change, however, BNPL’s business model is clearly flawed. If the CFPB does not lead to changes, another regulator will. It may well be that individual states do this. The state of California, for example, decided in 2020 that Affirm’s competitor Sezzle must stop making illegal and unregulated loans in that state and collectively repay borrowers nearly $1 million. Attorneys general in other states have also shown keen interest in the CFPB’s investigation in recent weeks, suggesting they are prepared to do their part to protect their residents.
That’s the catch. While the microloan industry may be legitimate and simply deserves more oversight and transparency, it may also be heading for a major, mandatory overhaul that squeezes much of its profit potential. Given that Affirm isn’t even profitable yet, that’s just too overwhelming an argument against owning part of the business.
Meanwhile say what you will about outrageous credit card interest rates but Synchrony Financial has been reliably profitable for a long, long time even shrugging off in early 2020 caused by the spread of COVID-19 later the same year.
SYF normalized diluted EPS (quarterly) data by YCharts
It also managed to stay off the regulatory radar while making those profits.
If you’re considering adding either of these two choices to your portfolio, the smarter choice here is the low-risk Synchrony, even though it doesn’t have the kind of sexy growth prospects that Affirm might. . There is a lot to be said for sure.
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Synchrony Financial is an advertising partner of The Ascent, a Motley Fool company. James Brumley has no position in the stocks mentioned. The Motley Fool owns and recommends Affirm Holdings, Inc. The Motley Fool recommends Lowe’s. The Motley Fool has a disclosure policy.
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