Traditional economic models often assume that individuals possess perfect financial literacy, enabling them to make informed borrowing and default decisions. However, in practice, many individuals exhibit far from perfect financial literacy. This discrepancy raises important questions about how financial literacy influences borrowing and default behavior. Given the central role of consumer credit markets in consumption smoothing, understanding the policy implications of widespread financial illiteracy is crucial. As a first step, I propose a novel framework for endogenous consumer default that incorporates financial literacy. Preliminary results suggest that subjective downward-biased perceptions of borrowing costs lead to over-indebtedness and, consequently, higher default risks.
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