Prepayment is the early repayment of a loan by a borrower, in part (commonly known as a curtailment) or in full, often as a result of optional refinancing to take advantage of lower interest rates.
[1] In the case of a mortgage-backed security (MBS), prepayment is perceived as a financial risk—sometimes known as "call risk"—because mortgage loans are often paid off early in order to incur lower interest payments through cheaper refinancing.
Similar issues arise for callable bonds in the American municipal, corporate, and government agency sectors.
In general, only borrowers who expect to keep their loans for many years should opt for below-market interest rates by paying mortgage origination points or forgoing automobile rebates.
Homeowner prepayment decisions are impacted by a number of variables and are notoriously hard to predict, adding another layer of uncertainty to investing in MBS markets.