If you own commercial real estate with a fixed-rate loan, you've probably seen the words "yield maintenance" or "defeasance" in your loan documents. And if you're like most borrowers, your eyes glazed over. These are two of the most misunderstood — and most expensive — provisions in commercial mortgage finance. This guide breaks them both down in plain English.
Here's the core issue: when a lender gives you a fixed-rate loan, they've committed capital at that rate for the full term. If you want to pay it off early — to sell the property, refinance at a lower rate, or restructure your capital stack — the lender needs to be compensated for the income they're losing. That compensation comes in the form of a prepayment penalty. Yield maintenance and defeasance are simply two different methods of calculating that penalty.
Both accomplish the same goal — making the lender whole — but they work very differently, cost different amounts, and have different implications for your deal. Let's walk through each one.
Here's the simplest way to think about it: yield maintenance is a mathematical formula — the lender runs a calculation and you write a check. Defeasance is an action — you're actually purchasing Treasury bonds to replace yourself on the loan. And in the right circumstances, defeasance can actually cost less than yield maintenance.
Yield Maintenance: The Concept
Yield maintenance is the simpler of the two. Think of it as writing the lender a check to make up for the interest payments they'll miss.
When you prepay a fixed-rate loan, the lender loses future interest income. Yield maintenance calculates the present value of that lost income and charges it to you as a lump-sum penalty at payoff. The formula essentially asks: "How much money would the lender need today to replace the income stream they're giving up?"
How the Math Works
The yield maintenance formula compares your loan's interest rate to the current Treasury rate for the remaining loan term. The bigger the gap between those two numbers, the bigger your penalty.
Here's a simplified example: You have a $10 million loan at 5.5% fixed with 5 years remaining. Current 5-year Treasuries are at 4.0%. The lender is "losing" roughly 1.5% per year on $10 million for 5 years — that's about $750,000 in total lost income. The actual yield maintenance penalty is the present value of that $750,000 stream, which works out to roughly $680,000.
If Treasuries had risen to 6.0% instead, your rate would actually be below market. In that scenario, the yield maintenance penalty would be minimal or even zero (though most loans have a floor of 1% of the loan balance).
The key insight: Yield maintenance penalties move inversely with interest rates. When rates drop, your penalty goes up (because the lender is losing a more valuable income stream). When rates rise, your penalty goes down. This is the single most important thing to understand about yield maintenance.
Who Uses Yield Maintenance?
Yield maintenance is the standard prepayment structure for life insurance company loans, bank portfolio loans, and some agency (Fannie/Freddie) multifamily loans. It's generally considered borrower-friendly compared to defeasance because it's straightforward, involves a single payment at closing, and doesn't require hiring third-party consultants.
Defeasance: The Concept
Defeasance is more complex — and more expensive to execute — but it doesn't actually "pay off" your loan. Instead, it replaces your property as the loan's collateral with a portfolio of U.S. Treasury securities that generate the exact same cash flows (principal and interest payments) that the lender was expecting from your loan.
Read that again, because it's the part that confuses people. With defeasance, the loan doesn't go away. You're not prepaying it. You're swapping the collateral. The lender keeps getting their payments — they just come from Treasury bonds instead of your property. And you walk away free and clear, with no further obligation on the loan.
How the Process Works
Defeasance is a multi-step legal and financial transaction. Here's what actually happens:
- You hire a defeasance consultant. This is a specialized firm that handles the entire process. They calculate the Treasury portfolio needed, purchase the bonds, coordinate with the lender and servicer, and manage all legal documentation. You don't do this yourself.
- The consultant builds a bond portfolio. They purchase U.S. Treasury securities (T-bills, T-notes, T-bonds, and STRIPS) that are specifically structured to produce cash flows matching your remaining loan payments — every single principal and interest payment, right down to the penny, through the maturity date.
- The bonds replace your property as collateral. The Treasury portfolio is placed in a special-purpose entity (SPE) that assumes the loan obligation. The lender's lien on your property is released, and the lender now holds the bond portfolio as collateral instead. The SPE makes the loan payments using the bond income.
- You're released from the loan. Once the collateral substitution is complete, you have no further obligation. The property is unencumbered. You can sell it, refinance it, or do whatever you want with it.
Why Is Defeasance More Expensive?
Two reasons. First, you're buying actual Treasury securities at market prices. When interest rates are lower than your loan rate (which is the same environment that makes yield maintenance expensive), you need to buy bonds at a premium to generate enough cash flow to match your higher-rate loan payments. That premium is, in effect, your prepayment cost.
Second, the process itself has significant transaction costs that don't exist with yield maintenance:
- Defeasance consultant fee: $25,000 - $75,000 depending on loan complexity
- Legal fees: $15,000 - $40,000 (your attorney, the lender's attorney, and the SPE formation)
- Servicer processing fee: $5,000 - $15,000
- Accountant and rating agency fees: $5,000 - $15,000 (for CMBS loans)
These transaction costs typically add $50,000 to $150,000 on top of the actual bond purchase cost. On a $10 million loan, you might be looking at $100,000+ in soft costs before you even buy the first Treasury bond.
Who Uses Defeasance?
Defeasance is the standard prepayment mechanism for CMBS (commercial mortgage-backed securities) loans. Because CMBS loans are securitized and sold to bond investors, the lender can't simply accept a lump-sum prepayment — the investors are relying on those payment streams. Defeasance solves this by maintaining the payment stream while releasing the borrower.
Freddie Mac also uses defeasance as its standard prepayment mechanism on multifamily loans. Some life insurance company loans require defeasance as well, though it's less common in those products.
Side-by-Side Comparison
| Yield Maintenance | Defeasance | |
|---|---|---|
| How it works | Lump-sum payment to the lender at payoff | Replace property collateral with Treasury bonds |
| Loan status | Loan is paid off and terminated | Loan continues — you're just released from it |
| Common in | Life company, bank, some agency loans | CMBS loans, some life company and agency loans |
| Transaction costs | Minimal — just the penalty itself | $50K - $150K+ in consultant, legal, and servicer fees |
| Timeline | Calculated and paid at closing (same day) | 30-60 days to execute (bond purchase, legal docs, lender approval) |
| Complexity | Low — a formula calculation | High — requires consultants, attorneys, and bond traders |
| Rate environment impact | Cheaper when rates rise, expensive when rates fall | Same directional impact, but with added transaction costs |
| Borrower choice? | Usually the only option in non-CMBS loans | Usually required by CMBS — not a choice |
Which One Costs More?
This is the question every borrower asks, and the answer depends almost entirely on the interest rate environment at the time you prepay.
When rates have fallen since you locked your loan: Both yield maintenance and defeasance will be expensive — potentially very expensive. If you locked a 5.5% rate and rates have dropped to 3.5%, you're looking at a penalty that could be 8-12% of the outstanding loan balance. On a $10 million loan, that's $800,000 to $1.2 million. With defeasance, add another $75,000-$150,000 in transaction costs on top of that.
When rates have risen since you locked your loan: Both penalties shrink dramatically. If rates are now higher than your loan rate, the lender isn't losing anything by letting you prepay — they can relend at a higher rate. In this environment, yield maintenance may be close to zero (subject to the 1% floor), and defeasance costs may be limited mostly to the transaction costs.
In general, defeasance is more expensive than yield maintenance because you're paying all those soft costs (consultants, lawyers, servicer fees) in addition to the economic cost of replacing the income stream. The underlying economic cost is roughly similar for both methods, but defeasance layers on $50,000-$150,000 in execution costs.
Real-world example: A client came to us with a $15 million CMBS loan at 4.75% with 4 years remaining. They wanted to sell the property. At the time, 4-year Treasuries were at 3.8%. The defeasance cost came in at approximately $520,000 — about $430,000 in bond premium costs plus $90,000 in transaction fees. Had this been a yield maintenance loan with the same terms, the penalty would have been roughly $410,000. The defeasance added about $110,000 in extra cost.
Can You Negotiate Your Prepayment Structure?
This is where your broker earns their fee. The short answer: yes, but it depends on the loan type and your leverage at origination.
CMBS loans: Defeasance is almost always required and non-negotiable. It's baked into the securitization structure. You can sometimes negotiate a shorter lockout period (the window before defeasance is even available), but you're not going to switch from defeasance to yield maintenance on a CMBS loan.
Life insurance company loans: There's more flexibility here. Many life company lenders will offer either yield maintenance or defeasance, and some will negotiate a declining prepayment schedule (e.g., 5%, 4%, 3%, 2%, 1% over a 5-year term) instead. This is worth pushing for, especially on smaller loans where defeasance transaction costs are proportionally higher.
Bank loans: Banks are often the most flexible. Many bank portfolio loans offer step-down prepayment penalties (5-4-3-2-1 or 3-2-1) that are significantly cheaper and simpler than either yield maintenance or defeasance. Some banks will even offer open prepayment after a lockout period. If prepayment flexibility matters to you, bank execution may be the right capital source.
Agency loans (Fannie/Freddie): These typically require yield maintenance, though the exact formula varies by program. Some agency programs offer a declining prepayment option in the final months of the loan term.
Strategic Considerations: When Prepayment Matters Most
Understanding your prepayment structure isn't just academic — it directly impacts your investment returns and exit flexibility. Here are the situations where it matters most:
You're planning to sell within the loan term. If there's any chance you'll sell the property before the loan matures, your prepayment penalty is a real cost that needs to be modeled into your return projections from day one. A $500,000 defeasance cost on a $15 million sale is a meaningful hit to IRR. Factor it into your underwriting at acquisition.
Rates are dropping and you want to refinance. This is the most painful scenario. Rates drop, you could refinance at a much lower rate, but the yield maintenance or defeasance penalty wipes out most of the savings. Run the numbers carefully. Sometimes it still makes sense to pay the penalty and refinance — sometimes it doesn't. The math depends on the remaining term, rate differential, and how long you plan to hold.
You're recapitalizing or bringing in a partner. If you need to restructure the capital stack (add mezzanine, bring in equity, buy out a partner), the existing senior loan's prepayment provisions dictate your options. A loan with a $300,000 defeasance cost may need to stay in place while you layer capital around it, rather than refinancing the whole stack.
You're approaching loan maturity. Most yield maintenance and defeasance provisions have an open window — typically the last 90 days before maturity — where you can prepay with no penalty. If you're within striking distance of that window, it may make financial sense to wait rather than pay a large penalty now.
How We Help Borrowers Navigate Prepayment
At Banyan Commercial Capital, prepayment analysis is a core part of how we advise clients — both at origination and throughout the hold period.
At origination, we negotiate the most favorable prepayment terms available for your deal. We push for yield maintenance over defeasance when possible, negotiate shorter lockout periods, and advocate for step-down schedules on bank and life company loans. We model the potential prepayment cost under different rate scenarios so you know what you're signing up for before you close.
During the hold, when clients call and say "I want to sell" or "rates dropped — should I refinance?", we run the actual yield maintenance or defeasance calculation, compare it against the economics of refinancing or selling, and give you a clear recommendation. Sometimes the penalty is worth paying. Sometimes it's not. We'll tell you which one — with the numbers to back it up.
When it's time to defease, we coordinate the entire process with experienced defeasance consultants, ensure competitive bond pricing, and manage the timeline so your sale or refinance closes on schedule.
The Bottom Line
Yield maintenance and defeasance both exist to make the lender whole when you prepay a fixed-rate commercial loan. Yield maintenance does it with a check. Defeasance does it by replacing the collateral with bonds. Both are more expensive when rates have fallen and cheaper when rates have risen.
The most important takeaway: understand your prepayment structure before you close the loan, not when you're trying to sell or refinance and discover a $500,000 surprise. Model the potential cost at origination, negotiate the best terms your deal allows, and factor prepayment into your hold and exit strategy from day one.
If you have a loan with yield maintenance or defeasance and you're considering a sale, refinance, or recap, call us. We'll run the numbers and tell you exactly where you stand.
Need a prepayment analysis on your current loan?
Whether you're evaluating a sale, refinance, or recapitalization, we'll calculate your yield maintenance or defeasance cost and help you decide the best path forward.
Email Us Call (561) 408-7500About the Author: Banyan Commercial Capital is an independent commercial mortgage brokerage based in Boca Raton, Florida, with a combined 80 years of experience in the commercial real estate finance market. We specialize in debt, mezzanine, preferred equity, and joint venture capital for commercial real estate, and have closed 200+ transactions totaling $2B+ in volume.