The unique characteristics of a mortgage-backed security are reflected in the prepayment model. Prepayment is an option held by individual home buyers. There are many factors influencing the home owner to prepay their loans.
For an alert home owner, interest rate levels could be the primary factor. They may refinance their homes when interest rates goes down.
Home owners may sell their homes for non-economic reasons, such as moving.
Prepayment may be due to credit levels or lack of knowledge: some people does not refinance their home even when interest rates decrease. In a old mortgage pool, qualified individuals have refinanced. Therefore, prepayment for remaining individual tends to be low and insensitive to interest rate movements. This factor is referred as the "burn-out factor".
As an example, the prepayment behavior of a mortgage-backed security might be expressed by the following 3-D graph.
All dealers publish their prepayment numbers monthly. Bloomberg also publishes a prepayment table called the Bloomberg Median. HedgeOne accepts inputs from Bloomberg. HedgeOne also accepts user-defined prepayment speeds.
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