PREPAYMENT BEHAVIOR OF “NONFIXED-PAYMENT” PRODUCTS
In an earlier section of this chapter, we reviewed the impact of the increased popularity of ARMs on prepayment speeds for fixed rate loans. The changing market for mortgage products has also impacted the prepayment behavior of adjustable rate loans, as well as loans with nonconstant payments such as interest-only products. In addition to the aversion to adjustable rate loans exhibited by a segment of the population, prepayments on loans with variable payment structures (which can be referenced as nonfixed-paymentproducts, for the purposes of this discussion) are highly dependent on factors related to the timing of payment changes.
The change in monthly payment for nonfixed products after a loan “recasts” depends on a number of interacting factors. (The term reset typically indicates when the rate of the subject loan changes; a recast indicates that the payments on the loan are recalculated, based on the new rate and remaining term.) Clearly, the level of the reference index is an important driver of the ARM payment after the loan recasts. However, whether the loan has an interest-only feature, and how long the interest-only part of the loan remains in effect, are also significant in dictating the post-recast payments required on the loan.
To illustrate this phenomenon, Exhibit 4.12 shows the necessary payments on hypothetical amortizing and interest-only hybrid ARM loans with 6.0% original note rates. For both products, ...