Buy now, pay later: How do mortgage pros deal with ‘phantom debt’?

Earlier this year, New Jersey-based mortgage broker Joe Racamato, president of Silex Financial Group Inc., changed his firm’s preapproval process for home purchase applicants.

Racamato is now orienting his team to look closely at clients’ bank statements to find multiple — and often interest-free — installments of a few hundred or thousand dollars paid to the same company on a biweekly or monthly basis. He wants to know whether the potential borrower has acquired a buy now, pay later (BNPL) loan.

Traditionally, Silex Financial Group ran the initial numbers for a potential borrower to qualify for a mortgage based on what’s on their credit report, according to Racamato.

“But we saw recently with a client that none of her buy now, pay later payments were on her credit report,” Racamato said in an interview with HousingWire. “And an underwriter told us that she was required by her lender to count the debts that were on the bank statement, including the BNPL loans.”

Racamato promptly called some lenders he partnered with to ask how they deal with BNPL loans. “One lender said if it’s not on the credit report, we don’t count it, even if it shows up on the bank statements,” he said. “Other lenders said if it’s on the bank statement, then we need to verify and document it, see how many months are left and what the monthly payment is.”

With differing guidance from lenders, Racamato decided to take a more dramatic approach. His team is now “scouring” bank statements, and if they see BNPL loans, they ask clients to pay them off. 

“These are folks who just started the preapproval process, so they haven’t found the home yet. It’s a little like preventive medicine,” Racamato said.

For his client, who had many BNPL loans on her bank statement, paying them off made a significant difference since her debt-to-income ratio was too high. She was fortunate enough to have the ability to repay the loans and meet the requirements to qualify for a mortgage. But as Racamato pointed out, not everybody has this financial flexibility.

Meanwhile, BNPL loans are growing rapidly. This type of short-term financing became popular during the COVID-19 pandemic when people — mainly young and underserved consumers — were stuck at home and shopping online.

‘Flying under the radar’

Based on public data from Affirm — a market leader in the BNPL space — Wells Fargo economists Tim Quinlan and Shannon Seery Grein estimate that BNPL providers originated $46 billion in loans in 2023.

By comparison, the Consumer Financial Protection Bureau (CFPB) issued orders to the five largest BNPL providers to submit their portfolio data for 2021. It found 180 million BNPL loans originated that year for a total of $24.2 billion. 

In a December 2023 report, the Wells Fargo economists wrote that after surveying the limited data available, they concluded that “BNPL is not a major problem for consumer spending yet,” but the products are growing quickly and flying under the radar of regulators and policymakers.

“But, until there is a definitive measure for it, there is no way to know when this phantom debt could create substantial problems for the consumer and the broader economy,” they added.

In the mortgage space, loan officers, brokers and lenders are trying to figure out the best way to deal with this type of debt amid what they call a lack of guidance or transparency. But these sources also told HousingWire that they don’t see an imminent “systemic risk” tied to BNPL debt.

“I wouldn’t say it’s been a huge problem for the debt-to-income ratio. It does affect that debt-to-income ratio, but normally not enough to where it’s moving borrowers from approval to ineligibility,” said Michael Metz, operations manager at V.I.P. Mortgage. “But there are some headaches in collecting the documentation.”

According to Metz, companies that offer these loans are getting better at providing documentation, but they “don’t necessarily make it easy.” Some borrowers get these loans in retail stores, and some don’t have access to the statements required by the mortgage industry that contain information related to the current payments and future installments. 

“That opens up a whole other challenge for the client because many of these are just apps and, apparently, in some of these apps, you can’t print off a statement with all your information on it,” Racamato said. “So, just documenting what the payments in the balance are can be challenging for some of these borrowers, especially those who are less savvy.”

Regulatory clarity

In a September 2022 report, the CFPB mentioned the risks of BNPL debt related to inconsistent consumer protections and excessive debt accumulation. On May 22, 2024, the bureau issued an interpretive rule stating that BNPL lenders are credit card providers and that consumers have legal protections, such as the right to dispute charges or demand a refund.

Some BNPL providers report these loans to credit bureaus. On its website, Apple Pay explains that it shares the loan and payment history information with Experian, noting that the debt might affect future credit scores once the data is incorporated into credit-scoring models. Meanwhile, Affirm also “reports some loans and repayment activity to Experian and may report to other credit bureaus in the future.” 

But both companies are examples of exceptions.

“We’re in a little bit of a gray area where some of these buy now, pay later lenders are reporting the information on the loans to credit bureaus, but you’ve got others that are not, and there’s not a lot of standardization on what’s been reported and what’s not,” said Matt Jones, a partner at financial services law firm Mitchell Sandler LLC.

Jones said this is a “double-edged sword” situation for mortgage companies and their borrowers.

“On the one hand, if you require these BNPL lenders to report to the credit bureaus, you can help borrowers who are essentially credit invisible and haven’t had a lot of credit history in the past to have some repayment history and qualify for a mortgage,” Jones said. 

“But on the flip side, it’s going to increase the debt-to-income ratio for borrowers who are on the margin for qualifying for a mortgage in a time when house prices are high, interest rates are high and it’s hard enough to qualify, particularly for lower-income borrowers.”

Matthew VanFossen, CEO of Absolute Home Mortgage Corp., a New Jersey-based lender, said that some large purchases could be made with BNPL loans, which will affect the debt-to-income ratio. If the lender is not informed, the debt could be considered undisclosed.

“We need to make sure that our borrowers are disclosing and understanding what they’re required to tell us about in case something is not on the credit report,” VanFossen said. “The biggest issue is having undisclosed debt not properly factored into the debt-to-income ratio of the borrowers.

“We haven’t seen any substantial impacts of the [BNPL] product in our operations. That can obviously add up as more consumers start using it, and then it will be more prevalent in the underwriting process. I guess it really depends on the consumers and how well they adopt a system like this.”

Secondary market distinctions

At the end of the day, industry experts say that a lender’s approach to BNPL may differ depending on secondary market investors. The government-sponsored enterprises Fannie Mae and Freddie Mac, which account for about two-thirds of the mortgages originated in the U.S., are examples.

A spokesperson at Freddie Mac told HousingWire that BNPL debt is not mentioned in its seller/servicer guide, “which means sellers are not required to include them in the DTI ratio.”

Meanwhile, a spokesperson for Fannie Mae stated that lenders must include all installment debt not secured by a financial asset as part of the borrower’s recurring monthly debt obligations when completing the risk analysis.

But “installment loans with a remaining term of 10 months or less may be excluded from the DTI calculation unless the payments would significantly affect the borrower’s ability to meet their credit obligations,” the Fannie Mae spokesperson added.

Jones said that Fannie is essentially leaving it to a lender’s discretion to determine whether a BNPL loan significantly affects the “borrower’s ability to meet their credit obligation,” even if it is a three- or four-month payment cycle.

Philip Crescenzo Jr., Southeast division vice president at Nation One Mortgage Corp., said he sees lenders estimating the borrower’s assets and comparing them to the BNPL loan balance.

“There are a few ways that you could approach it,” Crescenzo said. “Let’s say the client has $2,000 in their savings account, and the buy now, pay later loan, the balance is $1,000. It wouldn’t matter what the payments were in that scenario because they had the money and they could pay it off. They just choose not to.

“There is no clear direction. So, [lenders are] taking the asset approach. Is there enough to cover? If yes, we’re OK. And it will end in the short term, usually less than a year, so it’s less risky. And it hasn’t come up as a concern yet where I have a problem.”

But Racamato of Silex Financial said that clarity and consistency are essential in the mortgage industry. Although the BNPL loan does not represent an imminent risk to the industry, it can be difficult to adapt without clear guidance, he added.

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