Mortgage-Backed Securities: Products, Structuring, and Analytical Techniques

PREPAYMENT CONVENTION TERMINOLOGY

For fixed rate amortizing assets, such as fixed rate mortgages, home equity loans (HELs), and manufactured housing loans (MHs), the monthly scheduled payment, consisting of scheduled principal and interest payments, is constant throughout the amortization term. If the borrower pays more than the monthly scheduled payment, the extra payment will be used to pay down the outstanding balance faster than the original amortization schedule, resulting in a prepayment (or, as it is sometimes referenced, an “unscheduled principal payment”). If the outstanding balance is paid off in full, the prepayment is a “complete prepayment”; if only a portion of the outstanding balance is prepaid, the prepayment is called either a “partial prepayment” or “curtailment.” Prepayments can be the result of natural turnover, refinancings, defaults, partial paydowns, and credit-related events. (Such an event might occur if a borrower improves or “cures” his/ her credit, thus becoming eligible for a new loan with a lower interest rate.) The evaluation of prepayments is further complicated by the fact that there is an interplay between defaults, which are effectively “credit-related” prepayments, and prepayments attributable to declining interest rates.

Prepayments and defaults can be analyzed on both the loan and pool level. Loan-level prepayment analysis, which requires detailed loan level information, is more accurate than pool-level prepayment analysis, but is also ...