Refinancing risk

1. The risk that an early unscheduled repayment of principal on mortgage-backed securities(MBS) will occur when the underlying mortgages are refinanced by borrowers. All MBS buyers assume some level of prepayments in their initial yield calculations, but an increase in the level of refinancing (which usually occurs as a result of falling interest rates) means that MBSs mature faster and will have to be reinvested at lower rates.

2. For a mortgage borrower, the risk that he or she will not be able to refinance an existing mortgage at a future date under favorable terms.

Investopedia Says:
1. The prepayment estimates used to price mortgage-backed securities are made based on market conventions known as "speeds". There are two primary measures of mortgage prepayment speeds: the conditional prepayment rate and the Public Securities Association standard prepayment model.

2. Typically, refinancing risk is associated with short-term mortgage products such as hybrid ARMs and payment option ARMs. Borrowers often take on unforeseen risks when they assume that they will be able to refinance out of an existing mortgage at some planned future date - usually before a payment or interest rate reset date - to avoid an increase in their monthly payments. Interest rates might rise substantially before that date, or home price depreciation could lead to a loss of equity, which might make it hard to refinance as planned.

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In banking and finance, refinancing risk is the possibility that a borrower cannot refinance by borrowing to repay existing debt. Many types of commercial lending incorporate bullet payments at the point of final maturity; often, the intention or assumption is that the borrower take out a new loan to pay the existing lenders.

A borrower that cannot refinance its existing debt and does not have sufficient funds on hand to pay its lenders may have a liquidity problem. It may be considered technically insolvent: although its assets are greater than its liabilities, it cannot raise the liquid funds to pay its creditors. Insolvency may lead to bankruptcy, even when the borrower has a positive net worth.

In order to repay the debt at maturity, the borrower that cannot refinance may be forced into a fire sale of assets at a low price, including the borrower's own home, and productive assets such as factories and plant.

Most large corporations and banks face this risk to some degree, as they may constantly borrow and repay loans. Refinancing risk increases in periods of rising interest rates, when the borrower may not have sufficient income to afford the interest rate on a new loan.^{[citation needed]}

Most commercial banks provide long term loans, and fund this operation by taking shorter term deposits. In general, refinancing risk is only considered to be substantial for banks in cases of financial crisis, when borrowing funds, such as inter-bank deposits, may be extremely difficult.

Refinancing is also known as “rolling over” debt of various maturities, and may be referred to as rollover risk.

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