Dr. Healy’s Mortgage Prepayment Market Watch: August Speeds Slow Amid Continued Market Volatility

Mortgage prepayment speeds declined again in August, as higher mortgage rates and continued economic uncertainty weighed on borrower behavior. At the same time, changing borrower demographics and evolving refinance patterns are creating different prepayment dynamics across coupon cohorts.

In this month’s Mortgage Prepayment Market Watch, Dr. Healy examines the latest trends in residential mortgage prepayments, what the data is showing across coupon levels, and the market factors that could shape prepayment behavior in the months ahead.

Prepay Analysis

OBSERVATION: Overall, speeds were down once again in August. While the lowest coupon mortgagors have tired of holding onto their low rate mortgages and are starting to succumb to demographic pressures to refinance or move, rising mortgage rates are muting this trend. Accordingly, the slope of the WAC curve (prepay speeds by coupon) remains somewhat flat at the lower end of the curve, while increasing with coupon. Higher coupons, however, have also experienced a decrease in prepay expectations.

The overall theme for the month remains volatility. The Iranian War, gas prices, China/Taiwan, tariffs, Russia/Ukraine are all contributing to a great uncertainty as to what is coming next. Mortgage rates were up from last month. Inflation continues to be high, and we have a new Chairman that just raised rates further. Given that the national debt hit $40T, the general consensus is that this will continue.

The average coupon of all loans outstanding in this database ($5.9T) is 4.39% and 78% of all mortgages have coupons under 6.00%. 4% are now over 7% which is now becoming the high risk tranche. However, four distinct behaviors have appeared:

1. Some borrowers are hanging on to their low-rate mortgages and succumbing to demographic pressures (new home, job transfer, etc) to refi
2. Cash-out refis seem to be growing in popularity with approximately 10% of all new loans falling into this category
3. 4% of the outstanding loans are now close to or "in the money" (i.e. >= 7.0%)
4. Rates have increased another 10 bps in the last month and it seems probable that they will rise further

It is my expectation that speeds will stay low absent a "black swan" type of economic event.

Market Watch

August’s data continues to point to a low-speed environment, but the underlying borrower behavior is anything but static. As rates, demographics, housing activity, and economic uncertainty continue to evolve, understanding the factors driving prepayments remains critical to accurately assessing mortgage portfolio and MSR valuations.

Dr. Healy’s Mortgage Prepayment Market Watch provides a monthly look at those trends and the market dynamics behind the numbers.

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