Cash-strapped millennials who have maxed out their credit cards but just have to have that new T-shirt or a couple of pairs of jeans now have a new option when it comes to spending beyond their means; installment plans.
While such plans have been around for over 100 years, they are typically used for larger purchases - while credit cards have been the preferred method of paying later for smaller ticket items.
No anymore, according to Bloomberg. Three notable finance technology companies have hit the scene with installment services - a business model that established players such as Discover have warned might get dicey if the economy goes sideways and defaults spike.
Earlier this year, Australia’s Afterpay began offering installment plans in the U.S., joining Affirm, a San Francisco startup launched by PayPal co-founder Max Levchin. Square announced its own installments plan in October; so did Swedish payments company Klarna, which has teamed up with H&M to offer services in 14 markets it didn’t name.
Affirm and Afterpay say they’re targeting millennial shoppers by filling a gap between credit cards and store credit, which require lots of paperwork and a strong credit rating. Perhaps mindful of the new competition, established players such as Discover warn that these upstarts could run into trouble should the economy sour and defaults spike. -Bloomberg
To use the services, consumers apply online or via app to instantly learn whether they've been approved - and can click the installment option at the websites of participating retailers who offer the option to approved buyers.
Budget apparel retailer Cotton On began offering installments to US customers via Afterpay in August. According to E-commerce chief Brendan Sweeney, 20% of buyers are already using this feature - which allows customers to pay in four equal parts spread over six weeks with no interest.
"I was kind of skeptical that there would be a market for people interested in installments, but there clearly is," says Sweeny. "We’ve seen a remarkable uptake from millennial customers," while he adds that the average order is around $50.00.
And after Australian millennials largely abandoned credit cards following the 2008 recession, Afterpay - which says it has a $3 billion per year global sales run rate, became wildly popular for their interest-free payment plans. But how do they make money? They collect a fee of up to 6% from the retailer, while also collecting late fees from customers who miss payments.
According to a report from the Australian Securities and Investments Commission, late fees constitute 24% of Afterpay's revenue.
The company charges no interest, instead collecting a fee of as much as 6 percent of a sale from the retailer. Afterpay works with 20,000 merchants globally—including 1,000 now online in the U.S. where the company has signed up Urban Outfitters, Anthropologie and Free People. Based on its recent monthly performance, Afterpay says it has a global sales run rate of more than $3 billion a year.
Afterpay is betting American millennials will be just as keen on its service as their Australian counterparts. The company says 65 percent of the U.S. cohort don’t have a credit card, are 30 on average and are intrigued by using installments to pay for merchandise. Leslie Parrish, a senior analyst at researcher Aite Group, says the simplicity of installments is at the heart of the appeal. “You know precisely when you’ll pay off that loan,” she says. “That gives you more discipline.” -Bloomberg
Affirm, meanwhile, issued over $1 billion in loans last year - a figure they expect to double this year. The company says it works with over 1,300 merchants; including Expedia, Casper mattresses and Peloton. Unlike Afterpay, the company does charge interest of up to 20%. Repeat customers with a good payment history are typically charged lower interest, while those who default risk being turned away the next time they apply for installments.
Approximately 80% of applicants are approved by Affirm and Afterpay, which compares with roughly 50% approval rates for store credit. And while companies such as Discover are panning the modern take on an old practice, industry experts say that the algorithms used by installment companies should prevent chaos during a downturn.
"Their artificial intelligence and machine-learning algorithms is the secret sauce, allowing them to approve instantly a wider spectrum of borrowers not traditionally pursued by the legacy credit-card issuers," according to payments researcher Richard Crone of Crone Consulting LLC.
The nascent industry is tiny and its proponents say there is plenty of room to grow in the U.S., where more than half of American consumers have lousy credit and need alternative ways to finance their purchases. Still hurdles are emerging. Despite building a $1.8 billion business, Levchin acknowledges that most shoppers have no idea they’re using his company when they choose how to pay at checkout.
“We’ve built this enormous audience,” he says. “But a lot of them still don’t really know that much about us.” To become better known, Affirm in November said it was redesigning its logo and will start listing all the retailers it works with on its website. The company will also step up a focus on travel, letting consumers pay for vacations over time. -Bloomberg
Some in Australia have criticized Afterpay for their lending practices for imposing additional financial stress on "shopaholics," who are apparently being forced at gunpoint to make poor financial decisions. Critics say that the practice could ding consumers' credit ratings, while the Australian Senate launched an official inquiry into the practice of paying via installments.
"These services were created to facilitate impulse shopping that, for many, jeopardize their ability to afford necessary expenditures and to build needed savings," says Steve Brobeck, a senior fellow at Consumer Federation of America.
Perhaps broke millennials can use installment plans to purchase a tent to live in once they've exhausted all other resources.