According to the PSA Model, what happens to prepayment speeds on mortgages if interest rates are increasing?

In the context of the PSA Model, prepayment speeds on mortgages typically decrease when interest rates are rising. This phenomenon occurs because higher interest rates make refinancing less attractive for homeowners. When rates increase, the cost of borrowing rises, leading borrowers to stay in their existing loans instead of refinancing to obtain a lower rate. As a result, the incentive to pay off a mortgage early diminishes, resulting in a reduction in prepayment speeds.

Additionally, as interest rates rise, the overall affordability for potential homebuyers can decline, which may contribute to a slower housing market. Fewer transactions and less turnover can further dampen prepayment activity. This behavior is evidenced by historical data, which shows that prepayments tend to slow down during periods of increasing interest rates. Therefore, understanding this inverse relationship is crucial for evaluating mortgage-backed securities and related investment strategies.