💰 Prepayment Penalties, Yield Maintenance & Defeasance Explained 📊

🏦 Avoid Costly Surprises: Prepayment Penalties, Yield Maintenance & Defeasance 💡

💰 Understanding Prepayment Penalties, Yield Maintenance & Defeasance

When securing a commercial mortgage, most borrowers focus on interest rates, loan terms, and closing costs — but there’s another critical detail that can significantly impact your bottom line: prepayment penalties. These fees are designed to protect lenders from lost interest income when loans are paid off early. The two most common forms in commercial real estate finance are Yield Maintenance and Defeasance.

In this post, we’ll break down what these terms mean, how they work, and how to prepare so you don’t get caught off guard.

What is a Prepayment Penalty?

A prepayment penalty is a fee a lender charges if you pay off your loan before the agreed maturity date. While residential loans sometimes have small or no prepayment penalties, commercial loans — especially those tied to securitized products like CMBS loans — often have substantial ones.

Yield Maintenance

Yield Maintenance ensures the lender receives the same yield they would have earned had you not paid off the loan early. Essentially, you pay a lump sum that covers the difference between your loan’s interest rate and current market rates for the remaining term.

·         Pros: May be more predictable than defeasance in certain interest rate environments.

·         Cons: Can be very expensive if market rates have dropped since you originated the loan.

Defeasance

Defeasance replaces the collateral for your loan (usually your property) with a portfolio of government securities that replicate the cash flows of your loan’s remaining payments.

·         Pros: Can free the property from the mortgage lien, allowing you to sell or refinance.

·         Cons: Complex process with high transaction costs and the need for specialized professionals.

How to Plan Ahead

1.      Review your loan documents early — Know your exact prepayment structure before signing.

2.      Model multiple exit scenarios — Understand your penalty exposure if you sell or refinance before maturity.

3.      Work with an experienced mortgage broker — A broker can negotiate better terms upfront and help minimize penalty impact.

Key Takeaway

Prepayment penalties, yield maintenance, and defeasance are not “fine print” items — they’re critical loan terms that can cost hundreds of thousands of dollars if misunderstood. By understanding these clauses before you sign, you protect your flexibility and profitability.

💡 Pro Tip: At Medallion Mortgage, we guide clients through the fine print to ensure your financing strategy fits your long-term investment goals. Contact us before you refinance or sell to see if we can help you structure a better outcome.

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© 2023-2024 Bill Rapp, Medallion Funds LLC, Director of Capital Advisory