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Buy now, pay later plans help to reduce online cart abandonment

RACHEL MARTIN, HOST:

If you have shopped online recently, you may have noticed a new kind of payment option available. It's called buy now, pay later. And the basic model, offered by companies like Afterpay and Klarna, allows customers to buy what they want immediately and pay for it later in four interest-free installments. Alexi Horowitz-Ghazi of our Planet Money podcast explains the potential pros and cons.

ALEXI HOROWITZ-GHAZI, BYLINE: When you use buy now, pay later, you are essentially taking out a little loan. It's kind of like paying with a credit card.

TERRI BRADFORD: The difference is you aren't paying interest. It almost is, like, too good to be true.

HOROWITZ-GHAZI: Terri Bradford is a payments specialist at the Kansas City Fed. And she says buy now, pay later feels too good to be true because as long as you're able to clear a pretty low bar, like a soft credit check that won't show up on your credit score, these companies will front you the money for whatever you're buying. Then they'll collect in four installments from whatever bank account or debit or credit card you want. And it's all interest-free, which raises a pretty big question.

BRADFORD: Interest-free loans. Where's the value proposition in that? So where was the money coming from, right?

HOROWITZ-GHAZI: Right. Lending money is usually profitable because of some combination of interest and fees. But Terri and her research partner, Julian Alcazar, found that the fees in this model generally aren't high either.

JULIAN ALCAZAR: I was always expecting this gotcha moment. You know, when you watch a scary movie and you can hear the suspenseful music and then there's Michael Myers behind the door, that's what I was expecting.

HOROWITZ-GHAZI: It turns out instead of gouging their customers with hidden fees, buy now, pay later companies are taking their cut from the other side of the transaction by charging the businesses actually selling the goods. It costs them between 4 and 9 1/2% per sale. Credit card companies usually charge less, from 2 to 4%, which raises another question - why are more and more retailers opting for buy now, pay later?

BRADFORD: Yeah, it doesn't quite seem to jibe, does it?

HOROWITZ-GHAZI: What makes it jive (ph) is that buy now, pay later is helping businesses sell more stuff because it helps them reach people who don't usually buy on credit, people with bad credit or younger customers. On top of that, Julian says, buy now, pay later helps retailers with a problem they call cart abandonment, when people fill their shopping carts, but then when they head to check out...

ALCAZAR: They'll be like, I don't need to spend $200. What buy now, pay later does - it actually reduces cart abandonment because it makes large purchases seem smaller to the consumer.

HOROWITZ-GHAZI: Which can be dangerous. Amelia Schmarzo experienced this a couple of years ago when she started buying clothes online using buy now, pay later.

AMELIA SCHMARZO: It literally made the price, like - I kid you not - like, $8. So in that mindset, I was like, oh, my gosh, I can afford the world.

HOROWITZ-GHAZI: Amelia fell into a kind of shopping spiral. Before, her credit card statement had only ever been a few hundred dollars at the very most. But when she got the bill that month...

SCHMARZO: I saw that it was $2,000, which was my limit. And then I saw my debit card went from $700 to, like, $20. And that's when I was like, I am going to throw up.

HOROWITZ-GHAZI: Stories like Amelia's are part of the reason that regulators, like the Consumer Financial Protection Bureau, are now looking into how these services fit into existing credit regulations and mapping out the risks they may pose to the people who use them. Alexi Horowitz-Ghazi, NPR News.

(SOUNDBITE OF LOVE ABOVE'S "MOKHOV") Transcript provided by NPR, Copyright NPR.