1. However, the investor should note that not all aspects of prepayment behavior are explained by the spread between the coupon and the mortgage rate. The projected prepayments shown in Exhibit 30–5 are long-term averages. Month-to-month prepayment rates vary (for example, due to seasonality) even if mortgage rates do not change. If a substantial and sustained decline in mortgage rates occurs, then mortgage holders exposed to mortgage refinancing incentives for the first time initially exhibit a sharp increase in prepayments. This gradually decreases as the homeowners most anxious and able to refinance do so. This non-interest-rate–related decline in the prepayment speeds of premium coupons usually is referred to as “burnout.” The projected speeds shown in the declining-rate scenarios are the average of the high early speeds and lower later speeds. For seasoned coupons that have experienced a heavy refinancing period, burnout implies that prepayments may be less responsive to decline in interest rates. This applies to the majority of premium coupons currently outstanding. The age effect on prepayments is well known. Prepayment speeds are low for new mortgages and increase gradually until the mortgages are two to three years old, after which the age is less important.

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