Step-Down Prepayment Penalties (5-4-3-2-1) vs. Yield Maintenance
Prepayment penalties dictate the financial friction of selling a commercial property or refinancing prior to loan maturity. A Step-Down Prepayment penalty enforces a clear, declining percentage fee (e.g. 5% in Year 1, 4% in Year 2, scaling down to 1% in Year 5). Yield Maintenance is a complex mathematical formula that guarantees the lender their full expected interest yield by penalizing the borrower based on the delta between the note rate and prevailing U.S. Treasury yields.
Indicative Underwriting Matrix
Always review the promissory note definition of minimum yield maintenance floor percentages (typically 1.0% of payoff principal).
Formula Mechanics: Fixed Percentage vs. Treasury Yield Delta
A step-down penalty is simple arithmetic: on a $5,000,000 loan balance in Year 3 of a 5-4-3-2-1 schedule, the exit fee is exactly 3% ($150,000), regardless of whether Federal Reserve interest rates are at 2% or 8%.
Yield maintenance, however, guarantees that the lender earns the exact present value of all interest payments contracted through the remaining term. If prevailing Treasury yields are lower than the loan note rate, the lender calculates the lost reinvestment spread and charges it to the borrower. In falling rate environments, yield maintenance penalties can exceed 10% to 15% of the loan amount.
Frequently Answered Financing Questions
Verified answers to common borrower and broker inquiries regarding loan sizing, guidelines, and execution.
When is a step-down prepayment penalty better than yield maintenance?
A step-down penalty is superior if the borrower anticipates selling or refinancing during a declining interest rate environment, because step-down fees remain strictly capped at known percentages.
Yield maintenance penalties become punitive when rates drop, whereas step-down penalties scale down predictably each calendar year.
Submit Financing Scenario →What happens to yield maintenance prepayment penalties when interest rates rise?
When market interest rates rise higher than the note rate on the mortgage, the yield maintenance calculation drops to the contractual minimum floor (typically 1.0% of principal).
In rising rate environments, yield maintenance can actually be cheaper than a 3% or 4% stepdown penalty, as the lender can reinvest payoff proceeds at higher market yields.
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