What Is a Prepayment Model?
In lending, a prepayment model is used to estimate the level of prepayments on a loan portfolio that will occur in a set period of time, given possible changes in interest rates. Prepayment is the settlement of a debt or part of a debt before its official due date. It can either be made for the entire balance or for an upcoming installment.
PSA Prepayment Model
The PSA Prepayment Model is a prepayment scale developed by the Public Securities Association in 1985 for analyzing American mortgage-backed securities. The PSA model assumes increasing prepayment rates for the first 30 months after mortgage origination and a constant prepayment rate thereafter. This approximates real-world experience that during the first few years, mortgage borrowers:
- are less likely to relocate to a different home,
- are less likely to refinance into a new mortgage, and
- are less likely to make extra payments of principal
