Home Business 'Pay later' lenders have a problem with the credit bureaus

'Pay later' lenders have a problem with the credit bureaus

by SuperiorInvest

In recent years, shoppers have embraced buy now, pay later loans as an easy, interest-free way to purchase everything from sweaters to concert tickets.

However, loans are generally not reported on consumers' credit reports or reflected in their credit scores. This has fueled concerns that users may be taking on a huge amount of debt that is invisible to both lenders and financial regulators.

So in February, when Apple announced it would begin reporting loans made through its Apple Pay Later program to Experian, one of the three major U.S. credit bureaus, it seemed like a watershed moment for the fast-growing category. “buy now, pay later”. .

But none of the other big post-pay providers have followed Apple's lead. And while credit bureaus and lenders say they are interested in finding a way to work together, the chasm between the two sides remains wide, to the point that some pay-later companies are exploring creating a credit bureau. alternative credit to manage your loans.

“I haven't seen really significant progress,” said David Sykes, chief commercial officer at Klarna, one of the largest pay later companies.

Buy now, pay later loans allow consumers to pay for their purchases over time, often in four installments over six weeks, interest-free. They gained popularity during the pandemic, when they helped fuel the rise of online shopping. Rapid growth has continued: The retail industry attributed its record-breaking holiday sales in part to the popularity of pay-later products.

But Wells Fargo economists warned last year that “phantom debt” from post-payment loans “could create substantial problems for the consumer and the broader economy.”

Credit agencies argue that adding post-payment loans to the reporting system would benefit consumers, who could build credit by paying loans on time, and lenders, who would get a more complete view of consumers' indebtedness.

Pay later providers agree, in theory. But they worry that reporting on the loans will end up harming their clients. Existing scoring models penalize borrowers who take out many loans in a short period. This could be a problem for the pay later industry because, unlike credit card purchases, each pay later transaction is treated as a loan.

Some consumer advocates share that concern.

“The credit reporting system is a system that assumes monthly payments, assumes longer-term loans, and is simply not built to handle 'buy now, pay later,'” said Chi Chi Wu, senior attorney at the National Law Center. Consumer. “It's kind of a square peg and round hole.”

The consumer reporting industry in the United States has evolved over decades into a complex network of independent and sometimes competing players. Financial institutions (banks, mortgage brokers, auto lenders, and others) report loan information to three major credit bureaus: Equifax, Experian, and TransUnion. Those bureaus collect the data and provide it to lenders and consumers, as well as companies like FICO and VantageScore, which use it to produce credit scores.

The major credit agencies say they addressed the post-payment industry's concerns more than two years ago when they created a category for the loans. That should allow FICO and VantageScore to adjust their models to account for the unique characteristics of those loans and ultimately incorporate them into credit scores without penalizing users. (For now, the loans would be included in consumers' credit reports, but they would not be visible to lenders or incorporated into scoring models.)

“It's been a long road, but I think we're finally reaching a tipping point in the push toward data reporting,” said Liz Pagel, a TransUnion senior vice president who oversees the company's consumer lending business.

However, the pay later industry argues that the credit reporting system is not ready yet. For one, credit bureaus primarily receive data from lenders on a monthly basis, while pay later loans are typically paid biweekly. (The three major credit bureaus said that while monthly reporting was the default, lenders could report more frequently if they wanted.)

“It's just not fit for purpose yet,” said Klarna's Sykes. “And we haven't seen anything from the offices to suggest that's about to happen.”

Klarna reports on loans to TransUnion and Experian in Britain, where the system works a little differently. A rival, Affirm, reports some longer-term loans to Experian in the United States and says it expects to report shorter-term loans “eventually.”

Other major pay later providers, such as Afterpay, PayPal and Zip, said their concerns with the credit reporting system's handling of pay later loans had not been resolved.

“Our members continue to say it's still inadequate,” said Penny Lee, president of the Financial Technology Association, which represents many of the largest post-payments companies.

That argument took a hit in February, however, when Apple announced it would begin reporting loans made through its “Apple Pay Later” product, essentially a copy of the pay-in-four loans offered by Klarna, Afterpay and similar companies. , to Experiano.

Apple declined to comment, but in an earlier press release it said that while the loans would not be immediately incorporated into credit scores, it saw the move as a step toward “giving users the opportunity to further build their credit.” .

Silvio Tavares, CEO of VantageScore, said in an interview that Apple's announcement showed the credit reporting system's ability to handle post-pay loans.

“It's hard to be more sophisticated than Apple,” he said.

However, far from joining Apple, pay later providers appear to be exploring a system outside of the traditional credit reporting infrastructure. Last year, two former industry executives founded Qlarifi, a data aggregation platform specifically for post-payment loans. (Klarna's Mr Sykes is an investor.)

Alex Naughton, who left Klarna last year to help found Qlarifi and is now its chief executive, describes the company as having a more tech-savvy, agile approach to credit reporting. You will be able to collect and share data in real time instead of monthly, the standard for major credit bureaus.

“I don't think the existing infrastructure is capable of adapting that quickly,” he said.

Lenders and credit agencies agree that post-payment loans are unlikely to stay out of the credit scoring system forever. But it is unclear what will break the impasse. Ultimately, industry experts said, it will likely come down to one of two things: Either regulators will force pay-later companies to start reporting or market forces will.

“It's either going to be a market change or it's going to be a regulatory change,” said Shane Foster, a lawyer at Greenberg Traurig who specializes in financial regulation.

Regulatory action seems unlikely soon, at least at the federal level. The Consumer Financial Protection Bureau has hinted that it would like to see post-payment loans incorporated into the credit reporting system. But while the agency oversees the credit reporting industry — enforcing policies to ensure data is accurate and consumers' rights are protected — it has not attempted to require private companies to provide data to the bureaus.

Several states, including California, have taken steps to regulate the pay later industry, and others, including New York, are considering doing so. But those efforts would not require the loans to be immediately reported to the credit bureaus.

Banks and other traditional lenders report to the credit bureaus because the data is useful in making credit decisions and because it serves as a basis for encouraging borrowers to pay: if they don't, their credit scores will suffer.

Pay later providers may not feel much pressure to start reporting because their business is growing and most consumers are making payments, said Ted Rossman, senior industry analyst at Bankrate. But if the economy slows and more consumers start falling behind on their payments, lenders could decide they need to join the credit reporting system to judge the trustworthiness of borrowers.

“Delinquencies are pretty low, the labor market has been strong, so maybe that hasn't created the same urgency,” he said. “The phrase 'Buy now, pay later' has not yet had its true effect on delinquencies. People keep warning about it. Maybe that will ultimately be what drives change here.”

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