Setting Up and Managing Prepayment Options

How does PrecisionLender account for prepayment penalties?

It's difficult to determine if, or when, a borrower may choose to prepay their loan.
PrecisionLender provides the following three methods to address the risk of prepayment:
- Adjusting your target return to reflect that a loan with prepayment protection holds less risk since the "downside" of an early payoff has been reduced.
- Adding a prepayment rate to indicate the rate, expressed as a percentage, of the year balance that is anticipated to be paid off on top of the normal amortization. This will affect your loan's return.
- Adding an adjustment to the funding curve. The adjustment is often lowered for stronger prepayment options to reflect the higher penalty and/or smaller probability of prepayment.

PrecisionLender default prepayment options include:

1% - this penalty is 1% of the current loan amount if the loan is prepaid, regardless of timing.
3/2/1— this penalty allows the bank to charge the borrower in the amount of x% of the current loan amount at the time of the prepayment. Here, 3% of the current loan amount is the prepayment penalty when the prepayment occurs in year 1 of the loan. It follows that 1% of the current loan amount is the prepayment penalty when the prepayment occurs in year 3.
5/4/3/2/1—this penalty is the same as 3/2/1 except it represents a higher maximum prepayment penalty. The convention is 5% of the current loan amount as a prepayment penalty if the prepayment occurs in year one of the loan. It follows that 1% of the current loan amount is the prepayment penalty when the prepayment occurs in year 5. Beyond year 5, there is either no penalty for prepayment or a 1% penalty.
Yield Maintenance—this penalty incorporates the timing of the prepayment event and the interest rate on the loan into the prepayment penalty. This provision type calculates the present value of lost interest income for the remaining term of the loan compared to the present value of interest income on a replacement loan at current market interest rates.

Amortize (default option) - amortizes the loan using the typical mortgage approach.
Re-Amortize - dynamically recalculates payment and remaining balance amortization after each prepayment.

Constant Prepayment Rate (default option) - divides Constant Prepayment Rate by 12 to get the monthly prepayment rate.
Single Mortality - calculated as 1-(1-Constant Prepayment Rate)^(1/12).

There are 3 main ways to create Prepayment Options:

From the Products Pane of the Administration Section, click on the name of the product that you wish to add or edit prepayment options for.
Click the “Edit” button in the upper left corner.
Click on the “Prepayment Options” section of the product.
Click the "Replace With..." button.

Click on the 'Standard Set' and select the set of prepayment options to populate with, then click 'Finish'. All prepayment options will be replaced with the set you selected.

From the Products Pane of the Administration Section, click on the name of the product that you wish to add or edit guarantee types for.
Click the “Edit” button in the upper left corner.
Click on the “Prepayment Options” section of the product.
Click the "Replace With..." button.
Click on 'Other Products' and select the product to populate with, then click 'Finish'. All prepayment options will be replaced with the set you selected.

From the Products Pane of the Administration Section, click on the name of the product that you wish to add or edit guarantee types for.
Click the “Edit” button in the upper left corner.
Click on the “Prepayment Options” section of the product.
Click the "Add New Prepayment Option" button.
Fill in the details as appropriate. Remember to save the product when you are done editing.

Default
- Indicates the prepayment option that will be applied as the default assumption when pricing a new opportunity with that product. There can only be one default prepayment option.
Name
- This is the name of this prepayment option that will be available to the lender.
Prepayment Rate
- The amount per year, expressed as a percentage, that is anticipated to be repaid on top of the normal amortization.
Target Return Adjustment
- This is the amount that the Target Return will be adjusted if this prepayment option is selected.

To delete an existing prepayment option, simply click the () trash can icon to the left of the prepayment option you would like to remove.