What financial term describes the risk of reinvesting principal at lower rates after an early mortgage payoff?

The term that best describes the risk of reinvesting principal at lower rates after an early mortgage payoff is prepayment risk. Prepayment risk occurs when borrowers pay off their loans earlier than expected, which can happen in various situations, such as refinancing for a lower interest rate or selling the property. When this happens, investors who hold mortgage-backed securities may receive their principal back sooner than anticipated. They then face the challenge of reinvesting that principal in an environment where prevailing interest rates may be lower, which can lead to diminished returns. This risk is particularly pertinent in a declining interest rate environment, where the likelihood of borrowers paying off their loans early increases, thereby affecting the cash flow and yield that the investor was originally counting on.

Reinvestment risk is associated with the uncertainty of reinvesting cash flows at a rate comparable to the original investment's yield, but it does not specifically refer to the scenario of an early mortgage payoff. Credit risk pertains to the possibility that a borrower may default on their loan obligations. Interest rate risk relates to the potential for interest rates to fluctuate, impacting the overall value of fixed-income investments, but it does not specifically address the consequences of early loan repayments.