Defining Yield Maintenance In Commercial Mortgages
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.
Better Financing Starts with More Options$1.2M offered by a Bank at 6.0%$2M offered by an Agency at 5.6%$1M offered by a Credit Union at 5.1%Click Here to Get QuotesWhat 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.
Questions? Fill out the form below to speak to a commercial mortgage professional.
Related Questions
What is yield maintenance in commercial mortgages?
Yield maintenance is a type of prepayment penalty that enables lenders to receive a similar yield from the prepayment of a loan than they would have received through the completion of scheduled payments on the loan. Yield maintenance clauses specifically require that if a borrower is to prepay a loan, they are required to also pay the difference between the interest rate on the loan and the standing market interest rate on the prepaid capital up to the loan’s maturity date as a penalty. In other words, the purpose of yield maintenance is to compensate investors or lenders for the loss of their future interest income that occurs when a borrower pays a loan off early. For more information, please see Yield Maintenance Calculator.
How does yield maintenance work in commercial mortgages?
Yield maintenance is a clause in commercial mortgages that ensures a lender receives the same yield on a loan paid off early. It charges a yield maintenance prepayment penalty fee when the mortgage is paid off, which is calculated as the present value of the remaining mortgage payments, multiplied by the difference between the existing loan’s interest rate and the yield on a new Treasury note (with a term equivalent to the remaining loan term).
For more information, please visit Defeasance or Yield Maintenance: Which Is Better? and Yield Maintenance Calculator.
What are the benefits of yield maintenance in commercial mortgages?
The main benefit of yield maintenance in commercial mortgages is the lower capital requirements compared to defeasance. Yield maintenance can be handled with a simple (although not insignificant) payment as a one-time penalty, which leaves capital available for other uses, such as renovating a property or acquiring another building. Another advantage is its simplicity compared to defeasance. Once the calculations and payment are accepted by the lender, that’s it.
For more information, please see Defeasance or Yield Maintenance: Which Is Better? and Yield Maintenance Calculator.
What are the drawbacks of yield maintenance in commercial mortgages?
The biggest downside of yield maintenance occurs if this option is exercised in an environment where interest rates are falling. If a borrower plans to refinance at a lower interest rate, for example, the cost of yield maintenance may be greater than just continuing to make payments on the existing loan. As a result, the penalty could be far more expensive than if a loan had any one of a number of other prepayment penalties.
Another drawback is that yield maintenance requires a one-time payment as a penalty, which can be significant. This leaves less capital available for other uses, such as renovating a property or acquiring another building.
What are the alternatives to yield maintenance in commercial mortgages?
The alternatives to yield maintenance in commercial mortgages include a declining balance prepayment penalty, a flat fee prepayment penalty, and a step-down prepayment penalty. A declining balance prepayment penalty is a penalty that decreases over time, while a flat fee prepayment penalty is a one-time fee. A step-down prepayment penalty is a penalty that decreases after a certain period of time.
For more information, please see this article and this calculator.
How can I calculate yield maintenance in commercial mortgages?
You can calculate yield maintenance in commercial mortgages using the formula:
Yield Maintenance = Present Value of Remaining Mortgage Payments * (Interest Rate - Treasury Rate)
Or, you can use this Yield Maintenance Calculator to assess whether this might be a financially favorable option for your transaction.