The 'phantom debt' of buy now, pay later is growing and will soon hit some Americans hard

• Buy now, pay later plans gained popularity in 2023 as an alternative to high-interest credit cards.
• The risk of these loans is high and many are now due following the holiday.
• These debts could also become a burden for the economy but no one knows the true extent of its use.

One of the trendy ways to finance purchases is about to come back to haunt the US economy and no one knows how big of a problem it is.

Consumer spending kept the economy chugging along in the second half of 2023, and one of the key factors was the growth of installment plans, often called "buy now, pay later" (also known as BNPL). However, because of how these de facto loans are handled, they are being called "phantom debt," since no one knows just how pervasive they are or how much of an anchor they are on the American consumer.

In a report from Wells Fargo published in December, the company's economists found that buy now, pay later loans totaled $24.4 billion in 2021, or about 2.5% of the size of the US credit card market that year. That was a 1,000% increase compared to 2019, and that number could be much larger now.

The Federal Reserve Bank of Philadelphia explained in 2022 that one of the reasons we know so little is that buy now, pay later companies often do not report to credit agencies.

"BNPL loans are not currently reported to any of the major credit reporting agencies, and the firms themselves are understandably reluctant to share proprietary data in a competitive environment," the Fed wrote.

If the debts snowball for too many consumers, these installment plans could also become a problem for the US economy.

Buy now, pay later use surged recently and those bills are now due

The use of buy now, pay later plans skyrocketed during the 2023 holiday season. According to Adobe, which tracks online sales, buy now, pay later plans use was up 47% on Black Friday and 43% on Cyber Monday.

Rather than make a purchase using credit cards, which are now burdened with record-high interest rates, you can use an installment plan that allows you to pay off the debt in a specific amount of time without accruing interest, often in eight weeks or four months.

However, the payments for many of those loans are now starting to be due.

If consumers blew past their budgets during the holidays and didn't make payments on their buy now, pay later plans, they could face late fees and interest rates in the neighborhood of 30%.

Installment loans can provide credit to some Americans who might not otherwise qualify. However, an August survey of 2,572 consumers conducted by financial news and data platform PYMNTS found that nearly 64% of high-income earners — defined by PYMNTS as those making at least $100,000 annually — had used installment plans in the previous 12 months. That was higher than the overall rate of 60%.

Of course, most consumers go into these transactions expecting to make all the payments on time. Indeed, the Fed's "2022 Survey of Household Economics and Decisionmaking" found that 83% of respondents paid off their buy now, pay later programs on time.

But some people who pay off their loans are just delaying the thing they were avoiding. A Social Science Research Network study found that some consumers pay off their buy now, pay later plans with credit cards, which trade a 0% interest rate for rates often well above 20%.

While installment loans might be preferable for large-item necessities, these are not the most common purchases. According to PYMNTS' survey, 39.6% of respondents used buy now, pay later plans for clothing and accessories and 33.7% used them for groceries.

The 'phantom debt' could sneak up on the US economy

Wells Fargo economists Tim Quinlan and Shannon Seery Grein wrote that buy now, pay later programs could lead to an uptick in consumer debt because consumers may be more likely to take on additional debt if they know they spread out payments.

"And because no central repository exists for monitoring it, growth of this 'phantom debt' could imply total household debt levels are actually higher than traditional measures," the economists wrote.

According to Census and Economic Information Center data, household debt represented 64.1% of US GDP at the end of the third quarter in 2023.

Mark Luschini, chief investment strategist at the financial advisor firm Janney Montgomery Scott said on "Mornings With Maria Bartiromo" in December that the increased use of buy now, pay later programs might be a sign that the consumer is starting to crack. Luschini noted that these loans, when coupled with recent upticks in credit card delinquencies and accounts behind on payments, are a sign that some consumers — especially those with credit card debt and auto loans — are beginning to buckle under the pressures of the US economy.

While the Wells Fargo economists concluded that buy now, pay later may not be a huge problem yet, it is hard to be certain when an issue could occur.

"Our sense after surveying what limited data are available is that BNPL is not a major problem for consumer spending yet," they wrote. "But until there is a definitive measure for it, there is no way to know when this phantom debt could create substantial problems for the consumer and the broader economy."

Warren Buffett summed up the danger of buy now, pay later long before it even existed. While speaking with the US Government's Financial Crisis Inquiry Commission in 2010, he explained the pitfall of leverage or using borrowed money, even if your intentions are solid.

"If you don't have leverage, you don't get in trouble," Buffett said. "That's the only way a smart person can go broke, basically. And I've always said, 'If you're smart, you don't need it; and if you're dumb, you shouldn't be using it.'"

Buy now, pay later debt can be advantageous if used correctly. But it is still a debt.