DEFINITION of 'Burnout'

A period of slowing mortgage prepayment within a mortgage backed security (MBS). This usually occurs after the mortgages start to mature. When some percentage of the underlying loans fail to prepay after an interest rate cycle, this is known as burnout. Those borrowers who did not refinance during the first interest rate cycle are less like to do so if interest rates drop again.


BREAKING DOWN 'Burnout'

The rate at which the underlying loans of an MBS prepay is largely a function of current interest rates relative to the interest rates on the underlying loans. If current interest rates fall to a certain point below the interest rate on an existing mortgage, borrowers have an incentive to refinance. An MBS can go through several cycles of interest rates over its term. Prepayment risk is a substantial risk for investors in MBSs and investors look for MBSs with burnout because burnout lessens the prepayment risks.

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