What is Conditional Prepayment Rate (CPR)?
Prepayment risk is the risk that the borrower repays the amount before the contract term. Banks have developed methodologies to calculate the possible prepayment rate to manage the risk well. One such method for the calculation is the conditional prepayment rate which has become a benchmark. The CPR is the annual rate at which a mortgage pool balance is assumed to be prepaid during the life of the pool. A mortgage pool’s CPR is a function of past prepayment rates and expected future economic conditions.
Example of Conditional Prepayment Rate (CPR):
We have been given the formula to convert the CPR into a monthly prepayment rate. It is called the single monthly mortality rate (SMM) using the following formula:
SMM = 1 − (1 – CPR)1/12
If given the SMM rate, you can annualise the rate to solve for the CPR using the following formula:
CPR = 1 − (1 – CPR)12
An SMM of 10% implies that 10% of a pool’s beginning-of-month outstanding balance, less scheduled payments, will be prepaid during the month.