Are Rate Cuts a Bigger Risk or Reward for Affirm?

U.S. President Donald Trump hasn't been shy about what he'd like to see happen with interest rates, openly calling for the Federal Reserve to cut rates. That doesn't seem to be in the cards, given recent comments from Fed chair Kevin Warsh. But Affirm (NASDAQ: AFRM) shareholders shouldn't ignore the political and economic dynamics taking shape. The fintech company likely has a big preference for the direction of rates.

What does Affirm do?

Affirm is a buy-now-pay-later company, but it also has a card business and makes consumer loans. That gives it three potential sources of revenue: payments from retailers for offering zero-interest financing, transaction fees from card usage, and interest from loans. However, the underlying story here is consumer health. Affirm needs people to buy things for its model to work.

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A rate increase might allow the company to charge higher interstate rates, but it could also reduce consumer spending. That's a net negative, with the far bigger risk that too many rate increases too quickly could tip the economy into a recession. A recession would be a terrible outcome for Affirm. Rate increases would also increase Affirm's own cost of capital, crimping margins.

Mostly good news if the President gets his way

A rate cut, on the other hand, would make it easier for people to keep spending and lower the company's cost of capital. Those are big positives and would help the company to continue growing its business. It is actively expanding its retailer network and card business while also broadening its overseas reach. As long as demand for buy-now-pay-later remains robust, it will have an easier time on all fronts.

Lower rates wouldn't be all positive, as the company may have to lower the rates it charges on consumer loans. But that would likely be overshadowed by the increased opportunity for business growth. So, all in, Affirm is likely to support the call for rate cuts over rate increases.

Affirm is still a young business

All of that said, investors should tread with some caution here. Buy-now-pay-later is a relatively new model, and there isn't a material track record of how companies like Affirm will perform during a deep economic downturn. Affirm, for example, only came public in early 2021.

Meanwhile, the stock's price-to-earnings ratio is a lofty 65x. If rates move the way Affirm would like, the business may benefit, but the stock may not benefit as much as investors expect. And if rates move against the company, well, the stock could take a material hit if investor sentiment on the buy-now-pay-later model sours.

Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.