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Dissecting the Burnout Factor for Modeling Mortgage Refinancing

Dissecting the Burnout Factor for Modeling Mortgage Refinancing. Alec Zhixiao Lin, Lin’s Analytics. Contents. Two usages of burnout in analyzing mortgage prepayment - Pool level - Loan level Dissect burnout factor for loan level analysis - Incentive/desire - Eligibility Modeling

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Dissecting the Burnout Factor for Modeling Mortgage Refinancing

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  1. Dissecting the Burnout Factor for Modeling Mortgage Refinancing Alec Zhixiao Lin, Lin’s Analytics

  2. Contents • Two usages of burnout in analyzing mortgage prepayment - Pool level - Loan level • Dissect burnout factor for loan level analysis - Incentive/desire - Eligibility • Modeling - Data - Sample - Regression Method and Results

  3. Pool-level usage of burnout factor • Gradual exhaustion of eligible loans during a period of persistent low interest rate. • In such a period, the prepayment speed is not expected to remain flat across all months. More creditworthy borrowers will have their mortgages refinanced sooner and more quickly.

  4. Compare pool-level prepayment A very clear pattern: more creditworthy borrowers can get rate/term refinance sooner. The pattern is weaker for cash-out refinance. (Some borrowers initially intend for rate/term refinance but are later persuaded to opt for cash-out refinance.) Regular pattern: big volumes of purchase in summer, regardless of creditworthiness. Data source: Freddie Mac Single Family Home Performance History Data

  5. Loan-level usage of burnout factor A measure of a borrower’s incentive for refinancing where = coupon (or contract) rate of a mortgage = prevailing interest rate available for refinancing at period t Hypothesis: In the event of a market rate drop, the higher the coupon rate of a mortgage, the higher the incentive for mortgage refinance.

  6. Hypothesis is not confirmed by data After a certain threshold, the refinance rate start to decrease. Why?

  7. We enhance the formula LLPA: loan-level pricing adjustment, i.e., extra premium in interest rate depending on borrowers’ creditworthiness 1.1: interest rate should be at least 10% lower than the coupon rate to cover transactional and psychological cost for refinancing

  8. Revised prepayment rate As the spread between borrowers’ coupon and prevailing market rate increases, the eligibility for refinancing decreases. The spread between borrowers’ coupon rates and market rates are within reasonable ranges. The higher the spread, the higher the incentive for successful refinancing.

  9. A measure for burnout factor that combines incentive and eligibility

  10. Loan-level ModelingSample • Single-family home mortgages with 30-year fixed rate. • Three states - Georgia: most representative of US homeowners - Massachusetts: highest home prices - Tennessee: lowest home prices We want to see whether any commonality can be seen in variable behavior in these diverse samples.

  11. ModelingResults • LTV and burnout factor are most important predictors. • Interest rate and FICO score at origination exert moderate impact.

  12. Contact Information • Name: Alec Zhixiao Lin • Company: Lin’s Analytics • City/State: Los Angeles, CA • Phone: 703-593-4290 • Email: alecindc@gmail.com

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