JUST UNDER $1.1trn of revolving consumer debt—bills racked up on credit cards—was outstanding in America at the end of August. It is a dangerous type of debt. High interest rates and low minimum repayments mean balances can quickly balloon. But a group of fintech firms are growing fast by offering consumers an alternative.
Affirm, based in San Francisco, was founded in 2012 by Max Levchin, a serial entrepreneur who co-founded PayPal. Rather than offer a line of credit to be used at will, like a credit card, it gives loans of up to $15,000 for specific purchases, to be repaid in pre-agreed instalments. When a shopper makes an online purchase with one of its retail partners, for example Peloton, a seller of fancy exercise bikes, Affirm appears as a payment option at checkout. It does a roaring trade in financing for engagement rings and laptops.
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Affirm makes some of its money from interchange fees of 3-6% paid by these merchants. On a three-month loan that works out at about as much as if the item had been bought with a credit card and paid off over the same period. That allows it to offer short-term loans at zero interest. On longer-term loans the cost is fixed when the loan is taken out and does not accrue as with cred it cards, even if a payment is late.
The model for such firms was Klarna, which was founded in Stockholm in 2005 and became a bank in 2017. Like Affirm, it offers medum-term loans repaid monthly. But it also allows consumers to split small purchases, like clothing, into three to four fortnightly zero-interest payments. Afterpay, founded in Melbourne in 2014, also splits payments into four. Both charge late fees, but cap the total. Smaller rivals have sprung up, such as Sezzle, based in Minneapolis and founded in 2016, and Quadpay, based in New York and founded a year later.
Affirm made $2bn-worth of loans last year, says Mr Levchin. Klarna financed purchases worth $29bn in 2018, up by a third from 2017. In the year to June 30th the value of sales financed by Afterpay more than doubled, to $5.2bn. Such speedy growth is reflected in their valuations. Affirm is worth $2.9bn. Klarna raised $460m in financing at a valuation of $5.5bn in August. Afterpay, which went public at a valuation of $1.6bn in 2017, is worth $8.8bn.
They are a particular hit with younger customers, who tell pollsters that they fear credit cards. Affirm says half of its customers are millennials or younger. The average age of a Klarna customer is 32. A quarter of millennials in Australia have used Afterpay, compared with 16% of adults.
Until recently they lent only for purchases at selected outlets. For Afterpay and Klarna, these included Anthropologie, a home-goods and clothing store, and ASOS, an online retailer. But this is changing. In May Klarna launched an app allowing shoppers to pay in instalments at any retailer. On October 7th Affirm introduced an app that pre-approves users for credit they can spend anywhere.
In their latest iteration, such firms seem to approach the territory of credit cards. But Mr Levchin insists that they retain the crucial distinction that makes them a better bet for customers: pre-arranged repayment schedules for each purchase, which cap the amount they will pay.
At present losses are modest—around 1% of the value of financed sales at Afterpay, for example. But the firms are burning through cash to finance expansion, and few have yet lived through a recession.
There are reasons to be sanguine about their prospects during one, however. They have grown sufficiently large that regulators are keeping a close eye on them. They must interact constantly with banks, who intermediate their loans. If regulators had concerns, they could simply tell banks to stop doing business with them.
And their sophisticated credit evaluation uses big data and proprietary models to evaluate how much debt an applicant can bear. Customers are turned away if a loan seems beyond their means, and balances are low. Their methods have done well so far, but as the global economy weakens they will face a tougher test. ■