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.

BREAKING DOWN '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. Public Securities Association Standard ...

    An assumed monthly rate of prepayment that is annualized to the ...
  2. Prepayment

    The satisfaction of a debt or installment payment before its ...
  3. Constant Percent Prepayment

    Annualized estimate of mortgage loan prepayments, computed by ...
  4. Single Monthly Mortality - SMM

    In mortgage-backed securities (MBSs), this is the percentage ...
  5. Prepayment Penalty

    A clause in a mortgage contract that says if the mortgage is ...
  6. Prepayment Privilege

    The right given to a debt holder to pay all or part of a debt ...
Related Articles
  1. Investing

    The Risks Of Mortgage-Backed Securities

    Find out how weighted average life guards against prepayment risk.
  2. Investing

    Defeasance Reduces Commercial Real Estate Fees

    Try this alternative to short-term variable-rate financing when using leverage to buy property.
  3. Personal Finance

    7 Steps to Help Pay off Your Mortgage in Retirement

    A monthly mortgage payment can be hard to handle in retirement if you're not ready.
  4. Investing

    Introduction To Asset-Backed And Mortgage-Backed Securities

    In this article, we will go through the structure, along with some examples of ABS and valuation.
  5. Investing

    What's the Option-Adjusted Spread?

    The option-adjusted spread, or OAS, measures a fixed-income security rate’s spread and the risk-free rate of return that’s adjusted to account for an embedded option.
  6. Investing

    Peugeot in Talks to Acquire GM's European Business

    PSA looks to become Europe's second biggest car maker.
  7. Personal Finance

    Profit From Mortgage Debt With MBS

    Mortgage-backed securities can offer monthly income, a fixed interest rate and even government backing.
  8. Investing

    Subprime Is Often Subpar

    Proceed with caution when considering these short-term, high-interest mortgages.
  9. Small Business

    What is a Business Model?

    Business model is the term for a company’s plan as to how it will earn revenue.
RELATED FAQS
  1. Do FHA Loans Have Prepayment Penalties?

    Learn whether FHA loans have prepayment penalties, and find out the rules governing interest charges when prepaying your ... Read Answer >>
  2. What is the difference between deferred revenue and accrued expense?

    Understand the differences between deferred revenue and accrued expenses. Learn how each is recognized on the balance sheet ... Read Answer >>
Hot Definitions
  1. Book Value

    1. The value at which an asset is carried on a balance sheet. To calculate, take the cost of an asset minus the accumulated ...
  2. Dividend Yield

    A financial ratio that shows how much a company pays out in dividends each year relative to its share price.
  3. Fixed-Income Security

    An investment that provides a return in the form of fixed periodic payments and the eventual return of principal at maturity. ...
  4. Free Cash Flow - FCF

    A measure of financial performance calculated as operating cash flow minus capital expenditures. Free cash flow (FCF) represents ...
  5. Leverage Ratio

    Any ratio used to calculate the financial leverage of a company to get an idea of the company's methods of financing or to ...
  6. Two And Twenty

    A type of compensation structure that hedge fund managers typically employ in which part of compensation is performance based. ...
Trading Center