Prepayment Model

AAA

DEFINITION of 'Prepayment Model'

A model used to estimate the level of prepayments on a loan portfolio that will occur in a set period of time, given possible changes in interest rates. Prepayment models are based on mathematical equations and usually involve the analysis of historical prepayment trends. Prepayment models are generally used to value mortgage pools such as GNMA securities or other securitized debt products.

As interest rates rise, prepayment models factor in fewer prepayments. If interest rates fall, the opposite effect is accounted for, as more people will refinance their loans.

INVESTOPEDIA EXPLAINS 'Prepayment Model'

One of the most notable prepayment models is the PSA Prepayment Model by the Securities Industry and Financial Markets Association. The PSA model assumes increasing prepayment rates for the first 30 months and then constant prepayment rates afterward.

The standard model, referred to as 100% PSA or 100 PSA, assumes that prepayment rates will increase by 0.2% for the first 30 months until they peak at 6% in month 30. 150% PSA would assume 0.3% (1.5 x 0.2%) increases to a peak of 9%, and 200% PSA would assume 0.4% (2 x 0.2%) increases to a peak of a 12% prepayment rate.

RELATED TERMS
  1. Collateralized Mortgage Obligation ...

    A type of mortgage-backed security in which principal repayments ...
  2. Single Monthly Mortality - SMM

    In mortgage-backed securities (MBSs), this is the percentage ...
  3. Prepayment Privilege

    The right given to a debt holder to pay all or part of a debt ...
  4. Contraction Risk

    The risk faced by the holder of a fixed income security when ...
  5. Extension Risk

    The risk of a security's expected maturity lengthening in duration ...
  6. Ginnie Mae - Government National ...

    A U.S. government corporation within the U.S. Department of Housing ...
RELATED FAQS
  1. What is a Ginnie Mae security?

    A Ginnie Mae, or Government National Mortgage Association security, functions similarly to the process of lending someone ... Read Full Answer >>
  2. Who bears the risk of bad debts in securitization?

    Bad debts arise when borrowers default on their loans. This is one of the primary risks associated with securitized assets, ... Read Full Answer >>
Related Articles
  1. Bonds & Fixed Income

    Profit From Mortgage Debt With MBS

    Mortgage-backed securities can offer monthly income, a fixed interest rate and even government backing.
  2. Personal Finance

    Understanding Your Mortgage

    We walk through the steps needed to secure the best loan to finance the purchase of your home.
  3. Insurance

    Behind The Scenes Of Your Mortgage

    Four major players slice and dice your mortgage in the secondary market.
  4. Options & Futures

    These Financial Products Are Too Complex For The Average Joe

    Structured financial products are so elaborate that investors are unable to assess costs and risk.
  5. Credit & Loans

    Understanding The Mortgage Payment Structure

    We explain the calculation and payment process as well as the amortization schedule of home loans.
  6. Economics

    Understanding Perpetuity

    Perpetuity means without end. In finance, a perpetuity is a flow of money that will be received on a regular basis without a specified ending date.
  7. Credit & Loans

    Getting A Mortgage After Bankruptcy Or Foreclosure

    Millions of Americans had homes foreclosed and millions more went into bankruptcy. Here are the necessary qualifying steps to buying a home again.
  8. Taxes

    Will Itemized Deductions Get You A Bigger Refund?

    April and taxes are due soon. If you need to file your return, you might have to decide if itemizing your deductions this year will net you a better deal.
  9. Home & Auto

    Save $30,000 For A Home Down Payment In 5 Months

    Before tackling mortgage rates, home maintenance costs and utilities, every home buyer must first gather the funds for a mortgage loan down payment.
  10. Credit & Loans

    Getting A Mortgage When Building Your Own Home

    It's much harder to get a loan when you're building a home, not moving into one. Here's where to look and what to expect.

You May Also Like

Hot Definitions
  1. Interest Rate Risk

    The risk that an investment's value will change due to a change in the absolute level of interest rates, in the spread between ...
  2. Income Effect

    In the context of economic theory, the income effect is the change in an individual's or economy's income and how that change ...
  3. Price-To-Sales Ratio - PSR

    A valuation ratio that compares a company’s stock price to its revenues. The price-to-sales ratio is an indicator of the ...
  4. Hurdle Rate

    The minimum rate of return on a project or investment required by a manager or investor. In order to compensate for risk, ...
  5. Market Value

    The price an asset would fetch in the marketplace. Market value is also commonly used to refer to the market capitalization ...
  6. Preference Shares

    Company stock with dividends that are paid to shareholders before common stock dividends are paid out. In the event of a ...
Trading Center