Implied Mortgage Refinancing Thresholds

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Abstract
The optimal prepayment model asserts that rational homeowners will refinance if they can reduce the current value of their liabilities by an amount greater than the refinancing threshold, defined as the cost of carrying the transaction plus the time value of the embedded call option. To compute the notional value of the refinancing threshold, researchers have traditionally relied on discrete‐ or continuous‐time option‐pricing models. Using a unique loan level database that links homeowner attributes with property and loan characteristics, this study proposes an alternative approach for estimating the implied value of the refinancing threshold. This empirical method enables us to measure the minimum interest‐rate differential needed to justify refinancing conditional on the borrower's creditworthiness, loan‐to‐value ratio and other observable characteristics.

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