Curtailment as a mortgage performance indicator

Abstract

This paper studies the impact of mortgage curtailment behaviors on the subsequent default and prepayment performance. Although curtailment is not a popular event in the western countries, it is the dominant form of prepayment in Asia and other high saving rate regions. Using a sample of loan-level mortgage performance records from Taiwan, the results of the multinomial logit regressions indicate that curtailment is one of the most significant factors in predicting future default and prepayment probabilities of a seasoned mortgage pool. Mortgages with past curtailment are estimated to be 85% less likely to default and 23% more likely to prepay during the remaining life than a mortgage without any curtailment. Hence, ignorance of past curtailment records could lead to biased projection of default and prepayment and, hence, the pricing and hedging of a seasoned mortgage-backed security. By collecting and incorporating curtailment information, investors could more accurately estimate the fair market value, disclose risk-based capital, and perform effective hedging of a particular mortgage portfolio.