Assessing the Structural Impact of Prepayment Penalties on U.S. Mortgage Finance

Billionaire investor Bill Ackman has proposed a direct lever to lower mortgage rates: a new class of non-prepayable loans from Fannie Mae and Freddie Mac. In a recent post to President Trump and Treasury Secretary Bessent, Ackman suggested the government-sponsored enterprises offer mortgages where borrowers would face a penalty to refinance or pay off the loan early. He estimated this change could save borrowers about 65 basis points on a 30-year mortgage, effectively offering a choice between a standard loan at today's ~6% rate or a locked-in rate of 5.35% with a prepayment penalty.

The theoretical basis for this proposal is straightforward. The prepayment option is a valuable feature for homeowners, but it creates a significant risk for investors in mortgage-backed securities (MBS). Because borrowers can refinance when rates fall, investors face reinvestment risk and potential capital losses. To compensate for this uncertainty, MBS spreads-the premium over government bonds-have historically been elevated. Ackman's core argument is that by removing this optionality, the risk premium embedded in MBS could compress by nearly 100 basis points, directly translating to lower mortgage rates for consumers.

This idea arrives amid a flurry of policy action aimed at the same goal. President Trump has directed Fannie Mae and Freddie Mac to purchase $200 billion in mortgage-backed securities from the public market. The stated aim is to drive mortgage rates down and make homeownership more affordable. The market has already reacted, with the 30-year rate dropping to near 6% following the announcement. Ackman's proposal, therefore, presents a complementary, structural mechanism. While the GSE purchases are a temporary liquidity injection, the prepayment penalty product targets the fundamental cost of capital in the mortgage market by altering the risk profile of the underlying securities. It seeks to achieve rate compression not through buying bonds, but by changing the nature of the loans that back them.

Financial Mechanics and Market Implications

The proposal sets up a clear, quantified trade-off for borrowers. A homeowner could choose between a 30-year prepayable mortgage at today's ~6% rate or a 5.35% rate with a prepayment penalty. The 65-basis-point savings is the core incentive, framed as a potential lifeline for affordability. Yet this choice introduces friction. The penalty, likely modeled on historical standards of 6–12 months of interest, would lock the borrower into a lower rate for a defined period, typically 5 to 10 years. This mirrors commercial mortgage structures but represents a significant shift for the residential market, where prepayment has been a near-universal right.

For the GSEs, the impact is dual-edged. On one side, the reduction in refinancing risk is profound. By removing the borrower's option to refinance when rates fall, the GSEs would no longer face the capital loss and reinvestment risk that currently drives up the cost of their MBS. This could translate into a meaningful compression of their own cost of capital. On the other side, the operational burden is real. Implementing a new product line with varying penalty structures, lockout periods, and complex rules around portability and sale would require significant underwriting, servicing, and legal infrastructure. This adds cost and complexity to an already regulated entity. The key question is whether the savings from lower capital costs outweigh these new operational expenses.

The most significant market implication lies in the MBS universe. New tranches backed by these non-prepayable loans would command a lower risk premium. The market would price them with spreads closer to those of commercial MBS, which have long operated under similar constraints. This creates a bifurcated market: a lower-cost, non-prepayable segment alongside the existing, higher-cost prepayable base. The overall impact on mortgage rates, however, hinges entirely on adoption. If the product gains traction, the compressed spreads for new loans could gradually pull down the average cost of capital for the entire GSE book. But if uptake is limited, the effect would be marginal, leaving the vast majority of the mortgage market-and its embedded refinancing option-unchanged. The proposal's success, therefore, depends on convincing enough borrowers that the upfront savings justify the long-term loss of flexibility.

Structural Hurdles and Political Realities

The path from Ackman's theoretical proposal to a live product is fraught with regulatory, political, and market complexities. The first and most immediate barrier is the GSEs' own status. Fannie Mae and Freddie Mac have been under Federal Housing Finance Authority (FHFA) conservatorship since September 2008. Any new product line, especially one that alters the fundamental risk profile of their mortgage book, would require explicit regulatory approval from the FHFA. This oversight body is currently the sole authority managing the GSEs, creating a significant bottleneck. The proposal must navigate a process that is inherently cautious, given the institutions' fragile post-crisis balance and the potential for new risks to emerge.

This regulatory hurdle is compounded by a fierce political debate over the GSEs' future. President Trump has announced plans to take these companies public, but Ackman's specific proposal is being framed by critics as a form of "fake privatization." The accusation, as noted in the evidence, is that such a move would benefit hedge funds while exposing taxpayers to risk. This criticism strikes at the heart of the GSEs' political legitimacy. Their existence is justified by their role in providing affordable, prepayable mortgages. Introducing a product that locks borrowers into lower rates but removes a key consumer right could be seen as a step toward a more commercial, less consumer-friendly model. In a political climate where the GSEs are already a lightning rod, this proposal risks being deprioritized or actively opposed as a distraction from the broader privatization narrative.

The administration's simultaneous push for other housing affordability measures further complicates the landscape. In recent days, President Trump has announced a ban on large institutional investors buying single-family homes and directed the GSEs to purchase $200 billion in mortgage-backed securities. These are concrete, high-profile actions aimed at cooling the market and improving access. Against this backdrop, a more niche, structural change like prepayment penalties may struggle for attention and resources. The policy agenda is crowded, and the prepayment penalty faces an uphill battle to be seen as a priority when other levers are being pulled. The bottom line is that while the economics are clear, the political and regulatory machinery required to implement them is deeply entrenched and resistant to change.

Catalysts, Scenarios, and Key Watchpoints

The viability of Ackman's proposal hinges on a series of forward-looking developments that will test its structural logic against real-world friction. The first and most critical catalyst is regulatory action. Given the GSEs' Federal Housing Finance Authority (FHFA) conservatorship since September 2008, any new product line requires explicit approval. Investors should monitor for any formal request from Fannie Mae or Freddie Mac to introduce non-prepayable mortgages, or for the FHFA to signal a willingness to consider such a product. This regulatory green light-or its absence-will be the primary determinant of whether the proposal moves from theory to pilot.

If regulatory approval is forthcoming, the next phase will be a pilot program. The market's reaction to this real-world test will be decisive. Key watchpoints include the actual adoption rate by borrowers and the precise pricing of the new loans. The proposal's core claim of a 65 basis point savings on a 30-year mortgage must be validated. Early data on how many borrowers choose the locked-in rate over the standard prepayable option, and the specific penalty structures that emerge, will provide the first tangible evidence of the product's appeal and the true cost of capital compression. A low uptake would signal that the 65-bp incentive is insufficient to overcome the loss of prepayment flexibility, while strong demand would support the thesis.

Finally, the broader MBS market will offer a crucial benchmark. The proposal aims to create a lower-cost segment by removing refinancing risk. Therefore, observers should watch for shifts in the spread structure, particularly for non-QM loans which already feature prepayment penalties. As noted in the evidence, many non-QM loans include prepayment penalties designed to protect lenders. If the market begins to price new non-prepayable agency tranches at spreads closer to these existing non-QM products, it would confirm the anticipated risk premium compression. Conversely, persistent spread gaps would suggest the market remains skeptical of the new product's risk profile. The trajectory of these spreads will be a leading indicator of whether the proposal successfully alters the fundamental cost of mortgage finance.