Fears about rising prepayment speeds in the home equity lending industry are overblown, according to a report from Salomon Smith Barney.
Even in the current interest-rate environment, prepayment speeds are probably not at their historic highs despite surging competition for customers, according to the investment bank's Bond Market Roundup report.
"We don't see anything that will turn home-equity prepayment speeds into something like agency-product speeds," said Ivan Gjaja, a vice president, who co-authored the study.
Agency mortgages, or loans that can be sold to Fannie Mae or Freddie Mac, reach prepayment speeds of up to 70% in low interest-rate environments.
Home-equity prepayment rates have historically not exceeded 40%.
"Investors should not overestimate the responsiveness to interest rates," Mr. Gjaja said.
Prepayments have been at relatively high but steady speeds, and have not increased much from 1997 levels despite a 120-basis-point drop in interest rates since April, he said.
Historically, home equity loans have shown only a 6% increase in prepayment speeds with every 100-basis-point drop in rates.
In addition, home-equity loan balances are significantly lower than first-mortgage balances, the report noted.
Therefore, closing costs often negate any savings that a borrower might see from refinancing.
Prepayment speeds have been a hot button in the second mortgage industry, and increases have caused several lenders to take multi-million- dollar writedowns in the last six months.
Lenders that have taken writedowns because of prepayment increases include GreenTree Financial Corp., a St. Paul, Minn.-based manufactured housing lender, and Mego Mortgage Corp., an Atlanta-based subprime mortgage company.
Many lenders have blamed the increasing number of players in the market for the writedowns, which the report confirmed.
"For some issuers who maintain a steady profile of credit, we have seen a narrowing of spreads," Mr. Gjaja said, which indicates that companies are competing for customers by lowering rates.
In addition, issuers are offering longer-term loans to tempt borrowers who want lower monthly payments to refinance.
But the main incentive to refinance continues to be the lower rates available to those whose credit scores improve, the report said.
