Defining Yield Maintenance In Commercial Mortgages

What is a Yield Maintenance Prepayment Penalty?

Yield maintenance is a type of prepayment penalty for commercial mortgages which reimburses a lender for the potential returns they would have made if the borrower was not prepaying their debt. In essence, 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 falling interest rates, a yield maintenance prepayment penalty guarantees a higher profit than if the repaid funds were lent out under the terms of a new loan. Conversely, in an environment in which interest rates are rising, yield maintenance prepayment penalties decrease because the lender can earn more money by being paid off earlier and lending money at a higher rate. However, even if the interest rate has risen sharply and the lender will actually profit from your prepayment, they will typically include a 1% minimum prepayment fee.

If the borrower wants to pay off the loan early, such as in the event of a sale, it can be expensive. However, since many loans with yield maintenance prepayment penalties are assumable, commercial mortgage borrowers can pass this cost on to the buyer of the property by allowing them to assume the in-place debt.

Yield Maintenance vs. Defeasance

For commercial real estate loans that have been securitized, such as CMBS loans and many Freddie Mac and Fannie Mae Multifamily loans, yield maintenance is a standard alternative to defeasance. Unlike yield maintenance, which reimburses a lender for lost interest payments, defeasance actually substitutes the collateral of the loan itself. Borrowers who wish to defease a loan will generally have to purchase remaining principal amount in the form of U.S. Treasury or Agency bonds. Defeasance is often more expensive than yield maintenance, as it usually requires a team of experts to execute properly. However, this depends on market conditions, as well as the particular yield maintenance and defeasance requirements set by the individual lender.

Yield Maintenance Formula and Calculator

If you’d like to estimate the yield maintenance premium for a commercial real estate loan, try this formula:

Yield Maintenance = Present Value of Remaining Mortgage Payments  * (Interest Rate - Treasury Rate)

Or, check out this yield maintenance calculator to assess whether this might be a financially favorable option for your transaction.

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