Refinancing Incentive

Definition

Refinancing Incentive is the economic incentive of a Borrower to Refinance an existing borrowing with a new contract. The refinancing incentive is a key driver of Prepayment Risk.

Measurement

The measurement of the refinancing incentive invariably focuses on the net present value savings obtained when refinancing a loan with an existing applicable interest rate $C_{0}$ to a new loan at the current rate $C_{t}$. This difference measures whether the expected value of prepaying the loan/mortgage exceeds the value of not prepaying.

Issues and Challenges

• A strong refinancing incentive does not necessarily translate into actual Prepayment.
• A refinancing incentive as defined above does indicate whether prepayment is optimal