Question:

What is Conditional Prepayment Rate (CPR)?

Answer:

The Conditional Prepayment Rate (CPR) is the annualized expected rate of prepayment of principal for a pool of mortgage loans and mortgage-backed securities. Lenders are likely to be happy with a high CPR when mortgages interest rates are rising; when rates are going down mortgage pools with high CPR are considered undesirable by investors.

The Conditional Prepayment Rate (CPR) is used as prepayment measure for other loans, as well, and not only for mortgage loans. However, mortgage loans have direct correlation with existing mortgage interest rates and while when rates for other loans drop, prepayment levels are unlikely to rise dangerously. With mortgage loans, and especially fixed rate home loans, a drop of the interest rates signifies increased risk to investors, as homeowners tend to refinance.

How is the Conditional Prepayment Rate (CPR) used?

Well, a pool of loans with CPR of 11% means that 11% of the outstanding pool principal is expected to be paid off in the particular year.

Conditional Prepayment Rate (CPR) Formula

The formula for calculating CPR is based on another prepayment metric called Single Monthly Mortality (SMM). It represents the fraction of mortgage loans principal that has prepaid during the month on top of the regular principal payment.

Common conversion formula between CMM and SMM is CPR = 1 - (1 - SMM)12. A good approximation is CMM = 12 SMM.

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