Every minute of the day you are taking some kind of risk. Whether you are debating on sending that angry e-mail to your boss, eat that jelly donut, or are running down the street – there is always a level of risk involved. Some risks are obviously greater than others; and when it comes to the real estate market a refinance risk is something that borrowers and lenders must take part in.
When it comes to borrowers seeking to refinance their mortgage at more favorable terms or at a lower late, the refinance risk is simple. You risk not getting the mortgage you want at the terms you are happy with. This can be an extremely risky behavior if you locked in an adjustable rate mortgage loan and planned on refinancing before your payments jumped up. If you are unable to get refinancing prior to that time, you will have to make the larger payments to keep your mortgage current and the roof over your head.
However, when it comes to the lender the refinance risk is a bit larger. During the course of a mortgage a lender may choose to refinance. If they do find a new lender, they will then provide the money to the first mortgage and repay the original loan. Knowing that this unscheduled repayment of principal on mortgage-backed securities (MBS) will occur is the refinancing risk associated with loan providers.
Mortgage providers know that there are always going to be a portion of early repayment due to refinancing. However, if the interest rate drops suddenly a spike in refinancing typically happens. The result is that mortgage-backed securities become available more quickly and must be reinvested, generally at a lower rate of interest than was previously being earned.