What factor can be used as a proxy for cash-out refinancing incentives?
What will be an ideal response?
Cash-out refinancing is driven by price appreciation that has occurred since the origination of the loans in the pool. A proxy measure for price appreciation must be used. For the Bear Stearns agency prepayment model, the pool's HPI is used and Exhibit 11-11 illustrates the cash-out refinancing incentives for four assumed rates of appreciation of the HPI. The horizontal axis in the exhibit is the ratio of the pool's WAC to the prevailing market rate. A ratio greater than 1 means that there is an incentive to refinance while a ratio below 1 means that the borrower will incur a higher interest rate to refinance.
According to the Bear Stearns agency model, projected prepayments attributable to cash-out refinancing (1) exist for all ratios greater than 0.6, (2) prepayments increase as the ratio increases, and (3) the greater the price appreciation for a given ratio, the greater the projected prepayments.
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