Abstract
Mortgages allow for partial or complete prepayment at any time prior to the loan's maturity date. A mortgage prepayment is risky for the lending institution because it eliminates the borrower's obligation to pay future interest and complicates the steps required for refinancing the mortgage loan. Prepayment risk is a threat to mortgage-backed securities (MBS) that arises when borrowers pay down their mortgage principal more quickly than expected. For MBS investors, this means lower cash flows. A negative impact on cash flows and exposure to extension risk could result from actual prepayment rates being higher or lower than expected.
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