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.
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Finance allah shmoop shmoop What is a mortgage Well people
a mortgage is just dead it's alone but one with
special tax treatment For most people simply put Any interest
you pay on a mortgage to buy a home is
tax deductible Morty morton's inputs down a hundred thousand bucks
to buy a home that costs four hundred big ones
his mortgages three hundred grand at five percent interest per
year So that's fifteen thousand dollars a year he pays
to rent the money from the bank which he uses
to buy his dream home with the loop de loop
waterslide Morty earns one hundred grand a year and pays
tax on his last fifteen thousand of earnings soas faras
The irs is concerned since morty can deduct his fifteen
thousand dollars in interest against his earnings he does not
in fact earn taxable wages of one hundred grand annually
Instead he earns taxable wages of eighty five thousand dollars
a year Essentially with government is doing is sharing in
some of the cost of renting the money Taub i'm
ortiz home well why would the u s government be
so charitable Well because home ownership has been integral part
of the american dream since the u s of a
i po'ed in seventeen seventy six easy access to mortgages
and then home buying can be a hugely beneficial asset
In the vast majority of cases homes create family stability
a store of wealth and tax dollars for local schools
in the form of real estate taxes So don't feel
bad about splurging on that water slide there Morty Just 00:01:42.93 --> [endTime] remember you're doing it for the kids Hello