She never buys pools that have sizable portions made up of investment properties, as those have a lot of prepayment risk.
Prepayment risk is the risk that a given bond issue will be paid off earlier than expected, normally through a call provision.
Prepayment risk can be determined by many factors, such as the current and issued mortgage rate difference, housing turnover and path of mortgage rate.
FORBES: Introduction To Asset-Backed And Mortgage-Backed Securities
If the current mortgage rate is lower than the rate when the mortgage was issued or housing turnover is high, it will lead to higher prepayment risk.
FORBES: Introduction To Asset-Backed And Mortgage-Backed Securities
Prepayment risk is one of the big risks in owning mortgage-backed securities, but there are many others, including the risk of rising interest rates, falling interest rates, and defaults.
Prepayment risk is an important concept to consider in ABS and MBS. Therefore, to deal with prepayment risk, they have tranching structures, which help by distributing prepayment risk among tranches.
FORBES: Introduction To Asset-Backed And Mortgage-Backed Securities
Prepayment risk for auto loan ABS is much lower when compared to home equity loan ABS or MBS. Prepayment only happens when the borrower has extra funds to pay the loan off.
An investor in such a bond may wish to know what yield will be realized if the bond is called at a particular call date, to determine whether the prepayment risk is worthwhile.
Both ABS and MBS have prepayment risks, though these are especially pronounced for MBS. Prepayment risk is the risk of borrowers paying more than their required monthly payments, thereby reducing the interest of the loan.
FORBES: Introduction To Asset-Backed And Mortgage-Backed Securities
Keep in mind that municipal securities are subject to a number of risks including, but not limited to: Interest Rate Risk, the risk that the market value of fixed-income securities may fluctuate when interest rates change, and Prepayment Risk, the risk that the issuers of individual securities may prepay them at a time when interest rates have declined.
FORBES: Put Intermediate Muni Funds In Your Portfolio's Rotation
The remaining spread of the mortgage rate over the Treasury yield represents the risk of prepayment and underwriting costs.
But 4.5% would be the lowest mortgage rate in more than 30 years -- so the additional risk to lenders of prepayment would be almost nil.
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