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January 04, 2008


Holden Lewis

What's the difference between rate risk and early payoff risk?


Dick Lepre

Rate risk refers to the fact the the investor is lending the money at a fixed rate for 30 years but has no real way of knowing what rates will be in the future. If inflation gets out of hand there will be regrets on their part.

Early payoff risk refers to the fact that investors buy loans presuming that the cash flow will exist for some period of time, say, about five years. If the loan is paid off early they will have overestimated the value of the cash flow and in fact paid too much present value for it. If mortgage rates drop early payoffs occur.

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