Fintech

Meet BNPL's ‘recession-proof’ cousin: Lease-to-own

The financial agreements have had a reputation for misleading consumers. But entrepreneurs say technology can make them more transparent, flexible and efficient.

Image of a dissected house with a white picket fence around it

The decades-old business model is reemerging as a possible solution for customers who are feeling less flush.

Illustration: Christopher T. Fong/Protocol

With rising interest rates testing “buy now, pay later,” there’s an alternative way to break up a purchase into manageable payments: lease-to-own or rent-to-own agreements. As the fintech industry refocuses on customers who are feeling less flush, the decades-old business model is reemerging as a possible solution. It carries with it a somewhat unsavory history and potentially higher costs for consumers, making it a tricky business for fintech entrepreneurs and a complex investment for VCs to consider.

Lease-to-own or lease-purchase agreements are payment plans with additional fees, not loans. Under a lease-to-own agreement, a customer pays for a product in monthly lease payments, with some portion of the payment going toward owning the product. After a period of time, customers have the option to purchase in full or continue with their monthly payments until the end of the lease term. Profit is made through the fees customers pay: With many lease-to-own agreements, a customer who sticks with monthly payments through the full term will spend twice the cost of the product than if purchased outright.

Investors know that consumers like the idea of paying for purchases over time. According to a May study from PYMNTS, 10.2% of Millennials use “buy now, pay later” on a monthly basis. Data from LendingTree also published in May suggests that the market is growing, with one in three American consumers considering using a pay-later service.

But the “buy now, pay later” sector is facing headwinds, potentially opening up opportunities for a different approach. Consumers have less money to spend on big-ticket items, and rising interest rates are hiking the lending companies’ borrowing costs. That adds up to rising delinquencies, higher costs of operation and slimmer profit margins. According to The Wall Street Journal, 3.7% of Affirm customers were at least 30 days overdue on a payment in March this year, compared with 1.4% in March 2021. Yields on the company’s securitized offerings have risen sharply from a year ago.

Lease-to-own has some downsides. Retailers like Rent-A-Center and Aaron’s developed a poor reputation for selling low-quality products at high markups. Predatory rent-to-own agreements in the housing sector targeted low-income people of color. States have stepped in to regulate lease-to-own agreements, and four states outlaw them all together: Minnesota, New Jersey, North Carolina and Wisconsin.

But the business model’s advocates say the agreements enable subprime borrowers to make purchases they might not otherwise be able to afford. And fintech entrepreneurs say that technology can disrupt the model to make it more efficient, transparent and flexible so consumers don’t overspend or get left in the dark. “Programs like ours which give customers flexibility and benefits are going to become more prevalent,” says Neal Desai, CEO and co-founder of lease-to-own startup Kafene.

Most of the lease-to-own innovation in recent years has been in the area of home ownership, with companies targeting subprime borrowers who may not otherwise qualify for a mortgage. Divvy Homes, ZeroDown and Verbhouse are just a few. Adena Hefets, CEO and co-founder of Divvy Homes, told Money in April that about half of its customers are able to buy back their properties. The company declined to say how many customers become delinquent on their payments.

Kafene targets customers who would not qualify for “buy now, pay later” loans with their payment plans. Like the pay-later companies, Kafene partners with retailers, but makes money off of markups on the products rather than merchant fees. Customers can buy themselves out of a product’s lease early if they have the funds, saving money on an additional markup.

Retailers benefit from increased customer purchasing power, Kafene says — a pitch similar to that of “buy now, pay later” companies. Delinquency is uncommon under the lease-to-own model, Desai says, because customers who find themselves unable to continue with payments can return the item at no cost. And customers build credit as they make payments — a feature particularly beneficial to young consumers who are the prime market for payment plans, but are often averse to other credit-building products.

Ohad Samet, CEO and co-founder of debt collection startup TrueAccord, argues that lease-to-own operations are not delinquency-proof. His company performs collections for several, he says, though the company declined to name them. He also argues that “buy now, pay later” companies are not under major threat, pointing out that Klarna, a company where he was previously chief risk officer, was founded 17 years ago and is not new to economic changes. Lease-to-own serves a “small sliver of the market,” he says, and should be seen as “another avenue to acquire consumers and underwrite them.”

Many in the industry emphasize the importance of regulatory compliance. Lease-to-own agreements are regulated in slightly different ways in each of the 46 states where they’re permitted, which will require companies to tweak contracts depending on the jurisdiction. Transparency, like with all financial products, is also key for legal compliance: The FTC brought charges against rent-to-own company Progressive in 2020, for example, for deceptive marketing. The company was required to pay $175 million to settle. “Deceiving people about cost strikes at the heart of the FTC Act,” an FTC analysis of the settlement reads.

Still, the appeal of a recession-proof business model is likely to draw entrepreneurs. Though some are still bullish on “buy now, pay later” in a recession, it’s unclear how rising rates will pressure the business. According to Fitch Ratings, the credit quality of pay-later loans is “yet to be tested.” Competition from lease-to-own startups may provide another test.

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