This paper documents and interprets a fact central to the dynamics of informal consumer debt default: delinquency does not mean a persistent cessation of payment. In particular, we observe that for individuals 60 to 90 days late on payments, (i) 85% make payments during the next quarter to avoid getting into severe delinquency, and (ii) 40% reduce their debt (either because they made payments or received debt forgiveness). To understand these facts, we develop a theoretically and institutionally plausible model of debt delinquency and bankruptcy. Our model reproduces the dynamics of delinquency and suggests an interpretation of the data in which lenders frequently (in roughly 40% of cases) reset loan terms for delinquent borrowers, typically offering partial debt forgiveness, rather than a blanket imposition of the “penalty rates” most unsecured credit contracts specify.
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