Yield Maintenance & Defeasance

In large loans, the prepayment penalty may include a yield maintenance provision – sometimes called a ‘make whole.’ This penalty fee structure is intended to fully compensate a commercial mortgage lender for any lost interest between what the present rate is on the loan, and what the new rate is given the prepayment amount and the current interest-rate environment for the remaining term on the loan.

A large loan may also include a “defeasance” provision. As its name suggests, defeasance is a method of reducing fees in a commercial mortgage prepayment scenario: It allows borrowers to repay the loan by substituting the mortgage, and its stipulated interest rate, with a portfolio of securities (usually U.S.Treasury bonds).

However, both yield maintenance and defeasance provisions are only typical for large loans and rarely (if ever) affect loans under $5M.