Understanding Home Equity Loan Prepayments

Wesley Phoa, Ph.D.

Data from a number of different HEL programs has been used to analyse historical HEL prepayment behavior. Although prepayment behavior can be highly pool-specific, so that a generic model is inappropriate, some meaningful patterns may be observed in the data. Based on these observations, this paper sets out a frame-work for modeling HEL prepayments.

A basic knowledge of general program and pool characteristics will enable investors to formulate reasonable prepayment assumptions within this framework. However, given the level of variation between pools, more detailed prepayment analysis will add significant value to the investment management process, if used intelligently.

In addition, although HEL ABS have only mild negative convexity, they are subject to significant prepayment volatility and prepayment model risk; this may explain their high spreads relative to manufactured housing ABS. A key application of analytical systems and prepayment research is to allow investors to estimate potential bias in valuations and durations.