'Prepayment Score' Joins Credit Score as New Tool.

Lenders have long relied upon credit scores to assess the default risk of individual borrowers, and now one expert in prepayment modeling has created a score to assess a borrower's propensity to prepay.

Michael Bykhovsky, head of Applied Financial Technology here, said a couple of mortgage lenders are already using the system.

He says the option to prepay, which can wipe a lender's mortgage servicing asset off the balance sheet, costs lenders 10 times as much as the risk of default. Specifically, he says that on average, the default option is worth between three and 10 basis points per year for a loan, while the refinancing option is worth 30 to 100 basis points.

"When you read about companies going bankrupt in the mortgage industry in the last 10 years, it has never been about defaults. It has been about prepayments," Mr. Bykhovsky noted.

Typically, prepayment models focus on average characteristics for a given type of loan and are useful in portfolio analysis, but Mr. Bykhovsky's scoring system seeks to assess the difference in the propensity to refinance between different borrowers with the same loan. For example, two borrowers with a given loan type and interest rate on loans originated in a specific year might have different behavior patterns when it comes to refinancing the loan or prepaying the loan because of a move.

The new model creates individual scores based on over 20 criteria about the loan, including origination year, geography, household characteristics, income, loan-to-value ratio, and past prepayment behavior. Those characteristics are used to modify standard prepayment models for the individual scores.

He believes that individual prepayment scores could change loan pricing, in the way that credit scores have enabled "risk-based" pricing based on ...