Breaking Down Yield Maintenance and Defeasance

Unlike residential mortgages where you can refinance or sell at any time with minimal friction, commercial real estate loans (like CMBS and Agency debt) restrict prepayments to protect the lender's guaranteed yield.

If interest rates drop and you want to refinance to a lower rate, the lender will force you to pay massive penalties. The two most sophisticated penalty structures are Yield Maintenance and Defeasance. Understanding how these work is critical to commercial debt strategy.

Model your exact exposure using our Yield Maintenance / Defeasance Break-Even Calculator.

What is Yield Maintenance?

Yield maintenance is a mathematical penalty formula designed to guarantee the lender receives the exact amount of interest they would have earned if you kept the loan until maturity.

When you break a loan, the lender takes your payoff capital and reinvests it into a risk-free asset (typically a U.S. Treasury matching the remaining duration of your loan). Beause the Treasury rate is almost certainly lower than your original mortgage rate, the lender suffers a "yield spread."

• The Penalty: The borrower must pay the Present Value (PV) of this spread for all remaining months of the lockout period.

If Treasury rates plunge dramatically after you lock in your mortgage, your Yield Maintenance penalty skyrockets. If Treasury rates spike higher than your note rate, the formula generates zero penalty (though lenders invariably include a 1% minimum penalty floor in the contract).

What is Defeasance?

Defeasance is entirely different from a prepayment. It is a substitution of collateral.

Instead of prepaying the note, the loan remains completely intact. The borrower purchases a portfolio of U.S. Treasuries that precisely matches the remaining monthly cash flow obligations of the mortgage. This Treasury portfolio replaces the real estate as the collateral for the loan, allowing the owner to sell or refinance the actual building free and clear.

• Like Yield Maintenance, the cost of purchasing these Treasuries surges when Treasury rates are low, making Defeasance exceptionally expensive in low-rate environments.

The Refinance Break-Even Calculation

Property managers and investors must constantly balance the crushing upfront cost of these penalties against the long-term cash flow benefits of a lower interest rate.

If breaking your loan triggers a $400,000 penalty, but the new, cheaper loan saves you $15,000 a month in interest, your break-even point is 26 months. If you intend to hold the property for 5 more years, pulling the trigger makes immense financial sense.

Use our Yield Maintenance / Defeasance Break-Even Calculator to estimate your exact Treasury spread penalty and generate your break-even analysis without paying thousands to a loan servicer for a payoff quote.

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