Worse, because the consumer fails to see that she will pay a large penalty and back-load repayment—and not because she has a taste for immediate gratification with respect to consumption— she underestimates the cost of credit and borrows too much. Due to this combination of decisions, a nonsophisticated consumer, no matter how close to sophisticated, has discontinuously lower welfare than a sophisticated consumer. This discontinuity demonstrates in an extreme form our main point regarding contracts and welfare in the credit market: that because the credit contracts firms design in response postulate large penalties for deferring repayment, even relatively minor mispredictions of preferences by borrowers can have large.
