There's no denying the buy now, pay later (BNPL) movement has been embraced by a wide swath of the Western world. Roughly half of all U.S. consumers say they've used the store-supplied installment loan option at least once, according to data from C+R Research and Credit Karma. Indeed, many of these people have utilized a BNPL loan more than once, with furniture, electronics, and apparel among the most common purchases for this crowd of borrowers.
The creation of this form of lending has proven a boon for Affirm Holdings (AFRM -3.31%), which is not only one of the industry's leading names, but has largely modeled what the industry would become after launching back in 2013.
As the idea establishes itself, though, its flaws are starting to surface. It's arguable that the micro-purchase lending industry could swing back in favor of what was working well enough before BNPL mania took hold. That's good news for Synchrony Financial (SYF -1.33%), which supported this sort of consumerism quite nicely.
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The same, but different
You may be more familiar with Synchrony Financial than you realize. The company isn't exactly consumer-facing. But it's the lender behind a bunch of retailers' in-house revolving credit businesses. If you've got a credit card issued by J.C. Penney, Lowe's, Citgo, Napa Auto Care, or dozens of other retailers, you're actually a Synchrony customer.
Affirm's model is similar, though not identical. Rather than maintaining a revolving credit account for an individual, Affirm facilitates purchases of goods by extending time-limited installment loans -- usually a total of four. Loans typically range from a few hundred dollars up to $1,000, although they can be much higher. As is the case with Synchrony, using Affirm's service incurs interest charges.
In the cases of both Affirm and Synchrony, though, the lender is working directly with a retailer on a customer-by-customer basis.
An unregulated industry riddled with problems
One would think consumers view and use the two similar borrowing options in a similarly responsible way. That would be wrong, however. For reasons that aren't entirely clear, many BNPL borrowers seemingly struggle with their short-term loans more than consumers with revolving credit accounts do with theirs.
A survey performed last year by Credit Karma tells the tale. Of the 44% of U.S. residents it says have tapped the buy now, pay later market for a loan, 34% of them had fallen behind on their payments at least once. Of that 34%, 72% of them report their credit scores suffered as a result.
Were it the only hint that many individuals don't fully appreciate how quickly these microloans can become a burden, it might be dismissible. It's not the only clue, though. A similar survey conducted by Morning Consult in January of this year indicates 1-in-5 adults in the U.S. who still owes on a BNPL loan missed a payment that month. And, although not necessarily related, one out of every three of these borrowers also reports overdrafting a traditional bank account in the same month -- about twice the normal occurrence rate of overdrafts. Looking at the data from a different perspective, 2-in5 U.S. BNPL borrowers overdrafted a bank account in January.
Simply put, too many Americans have a money management problem that BNPL loans seem to exacerbate in a way conventional revolving credit accounts don't. That's why the Consumer Financial Protection Bureau (CFPB) opened an official inquiry into the entire industry -- including Affirm -- in December 2021.
There's a time and a place for risk, but this isn't it
Nothing's come of the Consumer Financial Protection Bureau's investigation yet. And it's possible nothing will.
With or without mandated change, though, it's clear the BNPL business model is flawed. If the CFPB doesn't drive changes, another regulatory body will. It may well be individual states that do so. The State of California, for instance, ruled in 2020 that Affirm's competitor Sezzle must cease making illegal, unregulated loans in that state, and collectively refund borrowers nearly $1 million. Other states' attorneys general have taken a strong interest in the CFPB's inquiry in just the past few weeks as well, suggesting they're willing to do their part to protect their residents.
There's the rub. While the microloan business may well be a legitimate one that simply merits more oversight and transparency, it may also be one that's heading into a major, mandated overhaul that crimps a big chunk of its profit potential. Given how Affirm isn't even profitable yet, it's all just too overwhelming of an argument against owning a piece of the company.
Meanwhile, say what you want about outrageous credit card interest rates, but Synchrony Financial has been reliably profitable for a long, long time, even shrugging the early 2020 headwind caused by COVID-19's spread later that same year.
SYF Normalized Diluted EPS (Quarterly) data by YCharts
It's also managed to remain off of regulatory radars while cranking out those profits.
If you're mulling the addition of one of these two picks to your portfolio, the smarter choice here is the lower-risk Synchrony even if it doesn't have the sort of sexy growth prospects Affirm might have. There's a lot to be said for certainty.
