Lesson 18 of 25 · 6 min

Status quo bias and the line that is never repaid

A facility with no maturity date poses the repayment question zero times, and the answer given by default compounds.

Status quo bias is the preference for the current arrangement over an equivalent alternative, sustained by the fact that changing requires an act and continuing does not. Its natural habitat is an arrangement with no scheduled decision points.

A revolving line is that arrangement. It has no maturity date, no amortisation schedule, and no anniversary at which anything is required. An amortising loan poses the repayment question sixty times over five years, and each instalment is a small forced answer. A revolving balance poses it zero times. The default option — the outcome that occurs when nobody does anything — is that the balance remains, and nothing about the statement identifies that as a decision.

Nine years of the default has a price. A balance of $224,000 at an illustrative 7.65 percent costs $224,000 × 0.0765 = $17,136 a year, and $17,136 × 9 = $154,224 over the period if serviced in cash from outside. If it capitalises instead, the balance becomes $224,000 × 1.0765^9 = $434,885, so the interest is $434,885 − $224,000 = $210,885.

That is 94.1 percent of the original draw, paid for the continued availability of a sum that was borrowed once. The compounding is the difference between the two figures: $210,885 against $154,224 is $56,661 of interest charged on interest, arising purely because the servicing was also a decision nobody was required to make.

The absence of a maturity date is a feature of the product and a property of the decision. Nothing ever arrives to interrupt the arrangement, so the arrangement is renewed silently, every day, by default.

Key terms

Status quo bias: Preferring the existing arrangement to an equivalent alternative, because staying requires nothing and moving requires an act.
Default option: What happens if no action is taken. Distinct from default in the credit sense, and far more consequential in a facility with no maturity.
Revolving facility: A line that can be drawn, repaid and redrawn with no fixed end date and no repayment schedule.

Worked example

Nine years of no decision

A $224,000 balance at an illustrative 7.65%, left outstanding for nine years.

Annual interest: $17,136
Nine years, serviced in cash: $154,224
Balance if capitalised instead: $434,885
Interest if capitalised: $210,885
Interest as a share of the original draw: 94.1%
Cost of compounding alone: $56,661

Nine years of taking no action costs almost exactly what was borrowed. No single month of it looked like a decision.

Check yourself

A $224,000 balance capitalises at 7.65 percent for nine years. How much interest accrues, and how does it compare with servicing the same balance in cash?

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Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.