Is Klarna just for indigents?
The Consumer Financial Protection Bureau (CFPB) has published a report analyzing the financial profiles of Buy Now, Pay Later (BNPL) borrowers. The report found that BNPL borrowers are more likely to be heavily indebted, revolve on their credit cards, have delinquencies in traditional credit products, and use high-interest financial services. Despite this, BNPL borrowers generally have access to traditional forms of credit and would face similar interest rates on credit cards. In 2022, 17% of US consumers used BNPL, with Black, Hispanic, and female consumers, as well as those with annual household incomes less than $50,000, and consumers under the age of 35, being much more likely to use the service.
This study confirms the long-standing belief that BNPL is a product for disadvantaged segments of society who simply do not have the means to make ends meet. Even Klarna’s recent collaboration with Paris Hilton seems to only exacerbate the situation as if attempting to disprove this notion.
Let us delve into the numbers and examine whether this is indeed the case. According to Census data, the median household income stands at $70,784, with households earning less than $50,000 accounting for over one-third of all households in the country.
However, does income level alone determine a family’s financial well-being? According to a PAYMNT survey, 63% of all Americans live paycheck to paycheck, and this figure is unsurprisingly higher with decreasing income levels. In the segment of households earning less than $50,000, this figure exceeds 77%. Yet, the most unexpected finding is that half (50.8%) of households earning more than $100,000 also “barely make ends meet” and live paycheck to paycheck.
Despite having similar spending habits, individuals with higher incomes will have a higher credit score, resulting in lower perceived risks and access to cheaper loans. For them, the choice between Klarna and a credit card’s grace period for an unplanned purchase is equivalent. However, the decision is more straightforward for individuals with low credit scores. Even with alternative credit products available, the choice between interest-free financing and a 20+% annual interest rate is quite evident.
The findings of C+R Research support that simplicity and low-interest rates (or the lack thereof) are determining factors when choosing to pay with BNPL.
Unfortunately, for the European market, a low credit score often means inaccessibility to credit for the majority of the population. Strict government regulation and financial institution conservatism significantly slow down innovation adoption in this field. As a result, according to the Worldpay report, we see a domination of cash and debit payments.
Thus, by lowering the requirements for credit scores and eliminating interest rates, BNPL makes lending more accessible to a broader population, which largely explains the fact that a significant portion of the population that previously faced limitations to credit instruments now has access to them. Meanwhile, higher-income buyers continue to use traditional financial instruments.
How does the Klarna financial model allow for a lower credit score, which should in theory lead to an increase in credit risk? The interest rate on a loan is primarily determined by two factors: the cost of funds (which is directly dependent on the refinancing rate) and the cost of credit risk. In its Q4 2022 report, Klarna announced that its default rate on loans had decreased to 0.58%, which is incredibly low compared to credit cards, where this figure can be orders of magnitude higher.
According to the latest report, Klarna facilitated purchases totaling $75 billion in 2022, while earning $760 million in revenue. This translates to an average commission of 1% of GMV charged to merchants. When annualized, Klarna earns approximately 8–9% in interest, which, in ordinary economic conditions and with low default rates, can make its financial model highly profitable, especially at scale.
How does Klarna manage to maintain such a high-quality loan portfolio? The answer is simple: simplicity and transparency. By dividing the purchase amount into equal parts without hidden fees, Klarna fundamentally changes customers’ attitudes toward credit purchases. Often, customers do not even consider installment purchases as credit purchases. For them, it is a regular purchase, simply spread out over time. This approach to calculating the minimum payment for loan repayment largely differentiates BNPL from credit cards, where even seasoned finance professionals may struggle to understand how the minimum payment is determined.
Another unique factor, specific to BNPL users, was revealed as a result of a survey of customers of the Vnoska, the installment card, a BNPL product that allows purchases only in installments from a wide network of online and offline partners. One in three or 33% of those surveyed emphasized that buying on installment allowed them to feel smarter, realizing the benefits of deferred payment. This became especially relevant in conditions of high inflation and rising prices. Customers said, “I’d rather buy this today and pay after payday than later when the price goes up.”
This attitude is what reduces credit risks for BNPL users. Customers who frequently buy on installment value this opportunity and perceive it as a privilege not to pay interest, but as assistance, they cherish this privilege and are afraid to lose it.
Another factor that should not be overlooked is that, unlike credit cards, BNPL providers are not interested in keeping customers in debt. The financial model of BNPL earns revenue from transaction turnover, not interest on the credit portfolio. Therefore, BNPL always strives for the customer to use their limit wisely and not fall behind on payments. Managing a credit portfolio results in losses for BNPL providers, so the customer’s financial health is essential to minimize losses and increase profitability. Moreover, a debtor always buys less, which means they generate less transactional revenue.
To sum up the above and answer the question “Is Klarna just for indigents?”, I can confidently say “NO”. BNPL significantly expands the audience that has access to modern credit solutions, reducing the entry threshold and making it simple and understandable to obtain and use such products. Customers, in turn, value the simplicity and transparency of BNPL, which reduces credit risks and benefits all participants in the process. Undoubtedly, as BNPL systems evolve, more and more high-income buyers will prefer interest-free installment plans over time. In fact, BNPL is changing the game in the credit industry, creating a more inclusive and accessible landscape for all consumers, regardless of their income level.
Read also “R.I.P. Klarna, or…?”
