Limited demand for choice flexibility – power of default and commitment in debt repayment

This paper studies why most households forego the option of more flexibility on their debt payments. The empirical evidence is based on a policy experiment that provided a free option to reduce minimum mortgage amortization to zero for 12 months. The offer was an unambiguous enlargement of the choice set as households could continue to amortize their mortgage even conditional on application. Yet, only one fifth of households apply. Evidence suggests that inattention matters for limited demand, but inattention or inertia are not sufficient explanations, because even many liquidity constrained bank employees do not apply. Furthermore, the evidence is consistent with a desire for commitment contributing to limited demand, given that conditional on application many households opt for a flexibility period shorter than the maximum. In the second part of the paper, I use a life-cycle model to understand limited demand due to inertia and a preference for commitment.