Hedging: Home Price Trends Factor Into New Prepayment Modeling.(Brief Article)

We all know that interest rates are the primary driver of refinancing activity. When rates fall, loans first become "cuspy." When rates fall again, chances are they are no longer on the cusp of refinancing, they are "in the money," meaning there's a good chance homeowners will seize the day and replace their current loan with one at a lower interest rate.

Not much can be done about that. You measure your risk, manage it and take what comes. But other factors also affect mortgage prepayment rates, and they are worth keeping an eye on as well. Analysts at Andrew Davidson & Company, New York, found that loans originated in different years with similar coupons behaved differently given similar rate incentives to refinance. Those differences could not be explained by existing variables in the firm's prepayment models, and they decided to look into this mystery.

Home price appreciation, they have concluded, is a significant and measurable factor in prepayment speeds. Faster home price appreciation makes it easier, and more tempting, for homeowners to refinance their loans. They can qualify for a new loan more easily and take cash out of the deal if they want.

In June, Andrew Davidson & Co. announced that they have added home price appreciation data to the Vectors Prepayment Models. Andrew Davidson, president of the firm, said the incorporation of home price appreciation data into the pool level model "represents a substantial change in thinking about prepayments." Home price appreciation data is in the models for conventional, government-backed and jumbo mortgage loans.

Until now, pool level models have focused primarily - if not exclusively - on interest rate driven factors. The home price appreciation data used by Andrew Davidson & Co. was provided by the Mortgage Risk ...