Appendix A

Analysis of Prepayment and Prepayment Rate

As mentioned earlier in the book, prepayment is defined as only the paydown of the outstanding balance of a mortgage pass-through that is in excess of its scheduled amortization. The speed of the excess paydown is measured by the prepayment rate. This appendix presents the measurement and discusses the fundamental reasons for prepayment.

Measurements of Prepayment Rate

Prepayment is the paydown of principal of a mortgage pass-through in a given month that exceeds the amount of its scheduled amortization for that month. The rate of prepayment is, therefore, the excess paydown in a given month as a percentage of the outstanding principal balance at the beginning of the month. This paydown is always measured on a monthly basis. Like interest rates, however, it is often expressed as an annualized rate. The prepayment rate of a mortgage pool is low right after its formation, but it accelerates as the pool ages. In the initial years, therefore, the prepayment rate is often measured in conjunction with the aging of the pool.

Single Month Mortality (SMM)

SMM measures the percentage of a pool's outstanding balance at the beginning of the month that was prepaid during the month. Algebraically, the SMM of month N, SMM_{N}, is calculated using the following formulas:

Where:

SF_{N} = scheduled factor at the end of month N

AF_{N} = actual factor at ...