Matched transaction-level, credit-registry, and survey data show that consumers over-extrapolate from unexpected income shocks to their income expectations. Over-optimistic income forecasts raise current spending and lead to greater debt accumulation and higher default when incomes subsequently fall short. A consumption-savings model with defaultable unsecured debt and extrapolative Kalman filtering, in which consumers overreact to income surprises reconciles our empirical findings and shows extrapolative expectations can generate state-dependent household debt cycles.