Is "buy now, pay later" good use or abuse?

“Buy now, pay later” offers have been gaining popularity, especially among young people. They offer a quick and easy way to obtain what you want now. About half of households now use them. But what are the ramifications, and what do they mean for your long run financial health?  In short, are the programs a good financial decision, or should they be avoided?

Borrowing is not new in the economy.  Consumer loans became popular in the 1920s due to dramatic changes in lifestyles. The economy was booming, household incomes were rising, people were moving from rural areas to cities, electricity was becoming more common, and the availability of electricity led to the emergence of refrigerators, washers, dryers, vacuums, radios, and numerous other consumer products we take for granted today. Vehicles were also replacing horse-powered travel.

Consumer loans were offered to allow households to more easily purchase these products, many of which were too expensive for the average person to buy with cash.  The amount of cash needed to purchase the product was loaned to the individual, and the individual then repaid the loan in equal payments over a specific period of time. Interest was also charged on the loan. If the borrower did not make all the payments, the lender could take – repossess – the item.     

Borrowing for long-lasting items, like homes, vehicles, and appliances, actually makes economic sense. The borrower is matching the benefits from the item with payments for the item. For example, if you have a 30-year home loan – generally called a mortgage – and you live in the home for 30 years, your periodic loan payments compensate for the benefits you enjoy from the home.  Of course, if you sell the home before the loan is paid, you’ll use some of the proceeds of the sale to pay the loan balance. Usually, home values increase over time, so owners make profits on home sales.  Indeed, home value increases have been more consistent than stock value increases.

The lesson is borrowing is a tactic that can be best be justified when the spending is used for something that provides value and use over many years, even something like a washer or stove. 

But there are also examples beyond items like homes, vehicles, and appliances where borrowing makes sense  College graduates certainly don’t look forward to repaying their college loans once they graduate.  But the graduates should look at the college loan as an investment.  Why?  Because the average college graduate will earn between $1 million and $1.2 million more in work earnings over their lifetime than the average high school graduate.   When this result is realized, college loans may not look that bad!

There’s another use of borrowing that also makes economic sense.  This is when the borrowing is done for a very short period of time.  For example, when my wife and I indulge in eating-out at a restaurant, we use our credit card for payment.  That way we don’t have to carry cash, which could be substantial if our dinner is for a special occasion, like a birthday or anniversary. But we always make a point of paying that expense on our next credit card bill so we’re not charged interest.  I call this “convenience borrowing.”

The toughest questions are about borrowing that is in-between the type that matches payments to benefits and convenience borrowing. I’m referring to borrowing for something that gives you immediate pleasure, but which you’ll pay for over time.  Remember, when you borrow you will pay more in total than if you paid in cash at the purchase. Time is money because money can always be invested and earn returns over time.  As a result, lenders charge an interest rate on the loan amount to give them a profit on their money and also to cover future inflation.

It's these “in-between” purchases that can be an issue. Say you have a very serviceable cell phone but are attracted to the new version that has many additional features.  You would really like to have those features, but the new phone costs in the four figures, and you don’t have the cash.  So, you borrow and have monthly payments for several years.  You are initially very excited with your new phone, but your excitement quickly dissipates.  Psychologists call this process an “hedonic treadmill.” More commonly it is called “buyers’ remorse.” Ultimately you wish you hadn’t bought the phone and instead used the money for payments for something else, like food, rent, or even savings.

It's not just people who struggle with borrowing. We don’t have to look any further than the federal government, which currently has a $37 trillion debt.  Just like people, some of this debt is for investments that have long term benefits, like medical research, education, transportation, and national defense.  But other debt is for spending that only provides one-time benefits.  Proposals have been made to separate federal financing into two parts, in which  borrowing can be used to finance spending that provides continuing long-term benefits, whereas borrowing would not be allowed for spending that only gives one-time benefits.

There’s a lot of overlap between economics and psychology when it comes to borrowing.  The long-run costs of borrowing, how long the benefits of borrowing will last, and the investment returns versus the psychological returns from what borrowing provides are all important elements to consider.  Can these principles be used to keep borrowing a good use and not abuse?   You decide.

Walden is a William Neal Reynolds Distinguished Professor Emeritus at North Carolina State University.