In mortgage-backed securities , this is the percentage of the principal amount of mortgages that are prepaid in a given month. For investors of MBSs, prepayment of mortgages is usually undesirable since future interest is foregone.
This is more broadly referred to as "prepayment risk." Due to the importance of prepayment risk, single monthly mortality was developed as a metric for tracking prepayments in the mortgage pool.
|||Prepayment hinders the returns for MBS investors because mortgages are normally prepaid using refinancing loan, and this happens primarily when interest rates have fallen. So while an investor in an MBS believes they have locked in a higher yielding investment in a low rate environment, they may in fact have the carpet pulled out from under them. The mortgage holders in the MBS may refinance at lower interest rates, and then pay off the mortgage in the MBS pool. Now the investor has their money back and must reinvest the funds in a lower interest rate environment.
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