What is a yield maintenance prepayment penalty?
Yield maintenance is a prepayment penalty on an existing commercial mortgage. It acts as a guarantee for the commercial property lender who made the original commercial mortgage, anticipating a set return over the full term of the loan. Unlike other prepayment penalties, yield maintenance covers the entire cost of the original lending agreement, compensating the lender fully for the prepayment of the borrowed funds.
Borrowers agree to yield maintenance clauses because lenders typically offer more favorable conditions, such as a lower interest rate, in exchange for this guarantee. In an environment of lowering interest rates, a yield maintenance prepayment penalty is a guarantee of a higher profit than if the repaid funds were to be lent out under the terms of a new loan. Conversely in an environment in which interest rates are rising yield maintenance prepayment penalties will decrease because the lender can earn more money by being paid off earlier and lending money out at a higher rate.
If the borrower wants to pay off the loan early, such as in the event of a sale, it can be expensive. However, commercial mortgage borrowers can pass this cost on to the buyer of the property by offering a buyer to assume the in-place debt as many loans with yield maintenance prepayment penalties are assumable.
Check out this yield maintenance calculator to help assess whether this might be a financially favorable option for your transaction.