CMBS Defeasance vs. Yield Maintenance: Prepayment Penalties & Exit Costs Compared
When commercial real estate borrowers pay off a fixed-rate mortgage prior to its stated maturity date, loan agreements typically enforce either Defeasance or Yield Maintenance. Both structures protect the bondholders or life company lenders against lost yield, but they operate through fundamentally different legal and financial mechanisms.
Indicative Underwriting Matrix
All defeasance costs, replacement yields, and penalty estimates depend on current Treasury yield curves, remaining loan term, and loan agreement definitions. BancorpOne provides debt advisory and connects sponsors with qualified defeasance consultants.
Defeasance: Collateral Substitution Mechanics
Defeasance is the standard prepayment mechanism in Commercial Mortgage-Backed Securities (CMBS) conduit loans. Because CMBS loans are bundled into collateralized pools and sold as fixed-income commercial mortgage bonds to pension funds and institutional investors, the underlying promissory note cannot simply be prepaid and cancelled without disrupting bond coupon streams.
Instead of paying off the debt, the borrower legally "defeases" the mortgage: they purchase a customized portfolio of U.S. Treasury bonds or Fannie Mae/Freddie Mac obligations whose monthly coupon payments and principal maturities exactly replicate the remaining mortgage payment schedule. The lender releases the real estate lien, allowing the property to be sold or refinanced, while the newly purchased Treasuries become the substitute collateral.
- Successor Borrower Entity: The existing borrower assigns the loan and substitute securities collateral to an independent "Successor Borrower" entity, freeing the original sponsor from all future liability.
- Accountant Verification: A certified public accounting (CPA) firm must issue a formal comfort letter certifying that the cash flows from the purchased Treasuries exactly match debt service obligations.
- Transaction Expenses: Because defeasance involves securities broker-dealers, legal counsel, rating agency reviews, and servicer fees, soft closing costs typically range between $50,000 and $100,000+ regardless of loan balance.
Yield Maintenance: Formula and Present Value Calculations
Yield Maintenance is predominantly used by life insurance companies, balance-sheet regional banks, and Fannie Mae/Freddie Mac agency lenders. Unlike defeasance, yield maintenance does not involve purchasing securities. Instead, the borrower pays the lender a lump-sum cash penalty at closing equal to the present value of the interest payments the lender would lose by reinvesting the prepaid principal at current Treasury rates for the remainder of the loan term.
The penalty is calculated as: Yield Maintenance Penalty = Present Value of Remaining Interest Stream at (Note Rate minus Replacement Treasury Yield). If current Treasury rates are significantly lower than the mortgage note rate, the yield maintenance penalty can be substantial. Conversely, if current Treasury yields exceed the note rate, the penalty drops to a contractually defined minimum (typically 1.0% of the outstanding principal balance).
Frequently Answered Financing Questions
Verified answers to common borrower and broker inquiries regarding loan sizing, guidelines, and execution.
Why do defeasance and yield maintenance costs decrease when interest rates rise?
When market interest rates and Treasury yields rise, replacement securities generate higher income, meaning fewer Treasuries are needed to replicate loan payments, reducing prepayment costs to contractual minimums.
In high-interest-rate environments, the spread between note rates and replacement Treasury yields narrows or turns negative, making loan exits significantly less costly than during low-rate regimes.
Model Prepayment Scenarios →What is the "open window" in a commercial fixed-rate mortgage?
The open window is the final 3 to 6 months of a commercial loan term during which the borrower can prepay the mortgage in full at par without any defeasance or yield maintenance penalty.
Borrowers preparing to refinance or sell an asset often target their closing dates within this open window to avoid paying tens or hundreds of thousands of dollars in exit fees.
Review Refinance Timelines →