Zero Prepayment Assumption

A zero prepayment assumption is a starting scenario for financial estimates. When we weigh opportunity costs (i.e. “would it be better to do A or B with my money?”), we have to start with some kind of baseline for comparison. When it comes to financial instruments, like mortgage-backed securities, which can have many complex layers of financial levers embedded into them, it helps to start with the most basic models, like a zero prepayment assumption.

After looking at financial modeling and risk for the zero prepayment assumption scenario, financiers can add additional layers (like including various prepayment rates) to see what the financial model churns out in comparison. Totally common to do with any debt-based security.

Prepayments are popular when people with mortgages decide to refinance, since many people do this when interest rates drop. They think “hey, we got this loan when interest rates were high...if we refinance, we can take advantage of the current interest rates, which are a lot lower,” making prepayments a steal of a deal. For real.