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class="vector-body" aria-labelledby="firstHeading" data-mw-ve-target-container> <div class="vector-body-before-content"> <div class="mw-indicators"> </div> <div id="siteSub" class="noprint">From Wikipedia, the free encyclopedia</div> </div> <div id="contentSub"><div id="mw-content-subtitle"></div></div> <div id="mw-content-text" class="mw-body-content"><div class="mw-content-ltr mw-parser-output" lang="en" dir="ltr"><p><b>Prepayment</b> is the early repayment of a loan by a borrower, in part (commonly known as a <a href="/wiki/Mortgage_loan#Principal_and_interest" class="mw-redirect" title="Mortgage loan">curtailment</a>) or in full, often as a result of <a href="/wiki/Option_(finance)" title="Option (finance)">optional</a> <a href="/wiki/Refinancing" title="Refinancing">refinancing</a> to take advantage of lower <a href="/wiki/Interest_rate" title="Interest rate">interest rates</a>.<sup id="cite_ref-ReferenceA_1-0" class="reference"><a href="#cite_note-ReferenceA-1"><span class="cite-bracket">[</span>1<span class="cite-bracket">]</span></a></sup> </p><p>In the case of a <a href="/wiki/Mortgage-backed_security" title="Mortgage-backed security">mortgage-backed security</a> (MBS), prepayment is perceived as a <a href="/wiki/Financial_risk" title="Financial risk">financial risk</a>—sometimes known as "call risk"—because <a href="/wiki/Mortgage_loan" class="mw-redirect" title="Mortgage loan">mortgage loans</a> are often paid off early in order to incur lower interest payments through cheaper <a href="/wiki/Refinancing" title="Refinancing">refinancing</a>. The new financing may be cheaper because the borrower's <a href="/wiki/Credit_rating" title="Credit rating">credit</a> has improved or because <a href="/wiki/Market_(economics)" title="Market (economics)">market</a> interest rates have fallen; but in either of these cases, the payments that <i>would have been made</i> to the MBS investor would be above current market rates. Redeeming such loans early through prepayment reduces the investor's upside from credit and interest rate variability in an MBS, and in essence forces the MBS investor to reinvest the proceeds at lower interest rates.<sup id="cite_ref-ReferenceA_1-1" class="reference"><a href="#cite_note-ReferenceA-1"><span class="cite-bracket">[</span>1<span class="cite-bracket">]</span></a></sup> If instead the borrower's opportunities deteriorate (creditworthiness declines or market interest rates rise), then the borrower loses the incentive to refinance, since the existing mortgage interest rate cannot be reduced with a new mortgage. The fact that MBS investors are exposed to downside prepayment risk, but rarely benefit from it, means that these bonds must pay an incrementally <i>higher</i> interest rate than similar bonds without prepayment risk, to be attractive investments. (This is the embedded "option cost" that results in a lower <a href="/wiki/Option-adjusted_spread" title="Option-adjusted spread">option-adjusted spread</a>.) Similar issues arise for <a href="/wiki/Callable_bond" title="Callable bond">callable bonds</a> in the American <a href="/wiki/Municipal_bond" title="Municipal bond">municipal</a>, <a href="/wiki/Corporate_bond" title="Corporate bond">corporate</a>, and <a href="/wiki/Government-sponsored_enterprise" title="Government-sponsored enterprise">government agency</a> sectors. </p><p>As another way to compensate for prepayment risk (which is a <a href="/wiki/Reinvestment_risk" title="Reinvestment risk">reinvestment risk</a>), a <b>prepayment penalty</b> clause is often included in the loan contract.<sup id="cite_ref-Simply_Mortgages_2-0" class="reference"><a href="#cite_note-Simply_Mortgages-2"><span class="cite-bracket">[</span>2<span class="cite-bracket">]</span></a></sup> "Soft" prepayment terms can allow prepayment without penalty if the home is sold. "Hard" prepayment terms do not allow any exceptions without penalty. </p><p>Bond issuers can mitigate some prepayment risk by issuing what are called "super sinker" bonds. Super sinkers are usually home-financing bonds that repay bondholders their principal quickly if homeowners prepay their mortgages. In other words, mortgage prepayments are used to retire a specified maturity. Super sinkers are likely to be paid off in a relatively short time. As a result, the bondholders may receive higher long-term yields after only a short period. </p><p>Individual borrowers who expect to prepay their loans early should generally favor a combination of lower principal balance and higher interest rate (which stops accruing after prepayment), rather than a below-market interest rate and higher principal balance (which much be paid in full, regardless of prepayment). In general, only borrowers who expect to keep their loans for many years should opt for below-market interest rates by paying mortgage origination points or forgoing automobile rebates. </p><p>Homeowner prepayment decisions are impacted by a number of variables and are notoriously hard to predict, adding another layer of uncertainty to investing in MBS markets.<sup id="cite_ref-ReferenceA_1-2" class="reference"><a href="#cite_note-ReferenceA-1"><span class="cite-bracket">[</span>1<span class="cite-bracket">]</span></a></sup> Prepayment speeds can be expressed in <b>SMM</b> (single monthly mortality), <b>CPR</b> (conditional prepayment rate, which is the annually compounded SMM), or <b>PSA</b> (percentage of the <a href="/wiki/PSA_prepayment_model" title="PSA prepayment model">Public Securities Association prepayment model</a>). For mortgages at least 30 months old, 100% PSA = 6.0% CPR = 0.51% SMM, equivalent to the full prepayment of 6% of a pool's remaining mortgages each year.<sup id="cite_ref-3" class="reference"><a href="#cite_note-3"><span class="cite-bracket">[</span>3<span class="cite-bracket">]</span></a></sup> </p> <div class="mw-heading mw-heading2"><h2 id="References">References</h2><span class="mw-editsection"><span class="mw-editsection-bracket">[</span><a href="/w/index.php?title=Prepayment_of_loan&action=edit&section=1" title="Edit section: References"><span>edit</span></a><span class="mw-editsection-bracket">]</span></span></div> <style data-mw-deduplicate="TemplateStyles:r1239543626">.mw-parser-output .reflist{margin-bottom:0.5em;list-style-type:decimal}@media screen{.mw-parser-output .reflist{font-size:90%}}.mw-parser-output .reflist .references{font-size:100%;margin-bottom:0;list-style-type:inherit}.mw-parser-output .reflist-columns-2{column-width:30em}.mw-parser-output .reflist-columns-3{column-width:25em}.mw-parser-output .reflist-columns{margin-top:0.3em}.mw-parser-output .reflist-columns ol{margin-top:0}.mw-parser-output .reflist-columns li{page-break-inside:avoid;break-inside:avoid-column}.mw-parser-output .reflist-upper-alpha{list-style-type:upper-alpha}.mw-parser-output .reflist-upper-roman{list-style-type:upper-roman}.mw-parser-output .reflist-lower-alpha{list-style-type:lower-alpha}.mw-parser-output .reflist-lower-greek{list-style-type:lower-greek}.mw-parser-output .reflist-lower-roman{list-style-type:lower-roman}</style><div class="reflist"> <div class="mw-references-wrap"><ol class="references"> <li id="cite_note-ReferenceA-1"><span class="mw-cite-backlink">^ <a href="#cite_ref-ReferenceA_1-0"><sup><i><b>a</b></i></sup></a> <a href="#cite_ref-ReferenceA_1-1"><sup><i><b>b</b></i></sup></a> <a href="#cite_ref-ReferenceA_1-2"><sup><i><b>c</b></i></sup></a></span> <span class="reference-text">Lemke, Lins and Picard, <i>Mortgage-Backed Securities</i>, Chapter 4 (Thomson West, 2013 ed.).</span> </li> <li id="cite_note-Simply_Mortgages-2"><span class="mw-cite-backlink"><b><a href="#cite_ref-Simply_Mortgages_2-0">^</a></b></span> <span class="reference-text"><style data-mw-deduplicate="TemplateStyles:r1238218222">.mw-parser-output cite.citation{font-style:inherit;word-wrap:break-word}.mw-parser-output .citation q{quotes:"\"""\"""'""'"}.mw-parser-output .citation:target{background-color:rgba(0,127,255,0.133)}.mw-parser-output .id-lock-free.id-lock-free a{background:url("//upload.wikimedia.org/wikipedia/commons/6/65/Lock-green.svg")right 0.1em center/9px no-repeat}.mw-parser-output .id-lock-limited.id-lock-limited a,.mw-parser-output .id-lock-registration.id-lock-registration a{background:url("//upload.wikimedia.org/wikipedia/commons/d/d6/Lock-gray-alt-2.svg")right 0.1em center/9px no-repeat}.mw-parser-output .id-lock-subscription.id-lock-subscription a{background:url("//upload.wikimedia.org/wikipedia/commons/a/aa/Lock-red-alt-2.svg")right 0.1em center/9px no-repeat}.mw-parser-output .cs1-ws-icon a{background:url("//upload.wikimedia.org/wikipedia/commons/4/4c/Wikisource-logo.svg")right 0.1em center/12px no-repeat}body:not(.skin-timeless):not(.skin-minerva) .mw-parser-output .id-lock-free a,body:not(.skin-timeless):not(.skin-minerva) .mw-parser-output .id-lock-limited a,body:not(.skin-timeless):not(.skin-minerva) .mw-parser-output .id-lock-registration a,body:not(.skin-timeless):not(.skin-minerva) .mw-parser-output .id-lock-subscription a,body:not(.skin-timeless):not(.skin-minerva) .mw-parser-output .cs1-ws-icon a{background-size:contain;padding:0 1em 0 0}.mw-parser-output .cs1-code{color:inherit;background:inherit;border:none;padding:inherit}.mw-parser-output .cs1-hidden-error{display:none;color:var(--color-error,#d33)}.mw-parser-output .cs1-visible-error{color:var(--color-error,#d33)}.mw-parser-output .cs1-maint{display:none;color:#085;margin-left:0.3em}.mw-parser-output .cs1-kern-left{padding-left:0.2em}.mw-parser-output .cs1-kern-right{padding-right:0.2em}.mw-parser-output .citation .mw-selflink{font-weight:inherit}@media screen{.mw-parser-output .cs1-format{font-size:95%}html.skin-theme-clientpref-night .mw-parser-output .cs1-maint{color:#18911f}}@media screen and (prefers-color-scheme:dark){html.skin-theme-clientpref-os .mw-parser-output .cs1-maint{color:#18911f}}</style><cite class="citation web cs1"><a rel="nofollow" class="external text" href="https://web.archive.org/web/20100504150327/http://blog.tophomemortgageloan.com/2010/04/when-do-i-pay-a-prepayment-penalty/">"Simply Mortgages — When Do I Pay a Prepayment Penalty?"</a>. Archived from <a rel="nofollow" class="external text" href="http://blog.tophomemortgageloan.com/2010/04/when-do-i-pay-a-prepayment-penalty/">the original</a> on 2010-05-04<span class="reference-accessdate">. Retrieved <span class="nowrap">2010-04-10</span></span>.</cite><span title="ctx_ver=Z39.88-2004&rft_val_fmt=info%3Aofi%2Ffmt%3Akev%3Amtx%3Abook&rft.genre=unknown&rft.btitle=Simply+Mortgages+%E2%80%94+When+Do+I+Pay+a+Prepayment+Penalty%3F&rft_id=http%3A%2F%2Fblog.tophomemortgageloan.com%2F2010%2F04%2Fwhen-do-i-pay-a-prepayment-penalty%2F&rfr_id=info%3Asid%2Fen.wikipedia.org%3APrepayment+of+loan" class="Z3988"></span></span> </li> <li id="cite_note-3"><span class="mw-cite-backlink"><b><a href="#cite_ref-3">^</a></b></span> <span class="reference-text">Hayre, Lakhbir, <i>Salomon Smith Barney Guide to Mortgage-Backed and Asset-Backed Securities</i> (Wiley: 2001) <link rel="mw-deduplicated-inline-style" href="mw-data:TemplateStyles:r1238218222"><a href="/wiki/ISBN_(identifier)" class="mw-redirect" title="ISBN (identifier)">ISBN</a> <a href="/wiki/Special:BookSources/978-0-471-38587-5" title="Special:BookSources/978-0-471-38587-5">978-0-471-38587-5</a>, p.24</span> </li> </ol></div></div>    </div><noscript><img src="https://login.wikimedia.org/wiki/Special:CentralAutoLogin/start?useformat=desktop&type=1x1&usesul3=0" alt="" width="1" height="1" style="border: none; position: absolute;"></noscript> <div class="printfooter" data-nosnippet="">Retrieved from "<a dir="ltr" href="https://en.wikipedia.org/w/index.php?title=Prepayment_of_loan&oldid=1199152176">https://en.wikipedia.org/w/index.php?title=Prepayment_of_loan&oldid=1199152176</a>"</div></div> <div id="catlinks" class="catlinks" data-mw="interface"><div id="mw-normal-catlinks" class="mw-normal-catlinks"><a href="/wiki/Help:Category" title="Help:Category">Categories</a>: <ul><li><a href="/wiki/Category:Structured_finance" title="Category:Structured finance">Structured finance</a></li><li><a href="/wiki/Category:Loans" title="Category:Loans">Loans</a></li></ul></div></div> </div> </main> </div> <div class="mw-footer-container"> <footer id="footer" class="mw-footer" > <ul id="footer-info"> <li id="footer-info-lastmod"> This page was last edited on 26 January 2024, at 04:58<span class="anonymous-show"> (UTC)</span>.</li> <li id="footer-info-copyright">Text is available under the <a href="/wiki/Wikipedia:Text_of_the_Creative_Commons_Attribution-ShareAlike_4.0_International_License" title="Wikipedia:Text of the Creative Commons Attribution-ShareAlike 4.0 International License">Creative Commons Attribution-ShareAlike 4.0 License</a>; additional terms may apply. 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