prepayment risk

Prepayment Risk

The uncertainty related to unscheduled prepayment in excess of scheduled principal repayment.

Notes:

This risk is generally associated with mortgage securities. It affects the value of these securities because any prepayments will shorten the life of the security. The return on the MBS will either increase or decrease depending on the frequency of prepayments and the likelihood of these prepayments being related to anticipated movements of interest rates.

See also: Contraction Risk, Extension Risk, Fannie Mae, Interest Rate, Mortgage Backed Security, Pass Through Security, Prepayment

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prepayment risk

The risk to a lender that part or all of the principal of a loan will be paid prior to the scheduled maturity. For a bondholder, prepayment risk refers to the possibility the issuer will redeem a callable bond prior to maturity. Prepayments generally occur when market rates of interest decline following the loan origination. Prepayment generally results in reduced cash flow for a bondholder when proceeds from the redemption are reinvested at a reduced interest rate. Also called call risk.