Money & Finance › Commercial real estate lending › Prepayment penalties: step-down, yield maintenance, defeasance
Yield maintenance: paying the lender's lost interest
· Concept
Fact, law or dataA rule, statute, definition or measured number.
A prepayment penalty that pays the lender the interest it loses by reinvesting the payoff at lower Treasury yields.
See it on the Money & Finance map →How it works
The formula: take the remaining scheduled payments, compare the loan rate with the yield on a Treasury maturing near the loan's maturity, and pay the present value of the difference. Example: $10 million at 6% with five years left and Treasuries at 4% costs roughly $0.9 million. Most loans set a floor, often 1% of the balance, which applies when Treasury yields exceed the loan rate. Some discount at Treasury plus 0.5%, which lowers the cost. Life-company, agency and some CMBS loans use it.
Why it matters
It makes prepaying cheap only when rates have risen or maturity is near; when rates fall, it wipes out the savings from refinancing and can trap owners who want to sell.
Facts, rules and data
Yield-maintenance formulas in loan documents, Treasury yields from the Fed's H.15 release, and lender and consultant calculators that apply them.
Debates and risks
Courts have split on whether yield maintenance is still owed after a lender accelerates a defaulted loan, and how to treat it in bankruptcy.
Connections (3)
▸Life insurance company loans: low leverage, long fixed rates usually carry Yield maintenance: paying the lender's lost interestFact, law or data
The connection
A life insurer funds a 10-year fixed-rate loan to match long-term policy obligations. If the borrower repays early when rates are lower, the insurer must reinvest for less, so yield maintenance makes up the lost interest. Many life-company loans also lock out prepayment for the first few years.
When and why
Standard in loan documents from insurers such as MetLife, PGIM and Northwestern Mutual; usually open to prepay without penalty in the final three to six months.
How we know
Published term sheets and loan agreements; insurers explain their asset-liability matching in NAIC filings and annual reports.
Debates and risks
How flexible insurers will be on prepayment in a workout, or when a borrower must sell, varies by lender and is negotiated case by case.
▸Yield maintenance: paying the lender's lost interest is calculated off yields on US Treasury securitiesFact, law or data
The connection
The lender's loss is measured against the safest reinvestment: a Treasury maturing near the loan's maturity. The lower that yield, the bigger the gap and the penalty. When Treasury yields rose sharply in 2022–23, many yield-maintenance penalties fell to their 1% floors.
When and why
In loan documents nationwide; most use a Treasury yield from the Fed's H.15 release a few days before payoff.
How we know
Yield-maintenance clauses in loan agreements and the Fed's published H.15 yields.
Debates and risks
Loans differ on which Treasury, whether to interpolate between yields, and what spread to add, which can shift the bill by tens of thousands of dollars.
▸Yield maintenance: paying the lender's lost interest is the cash alternative to Defeasance: swapping the building's collateral for TreasuriesFact, law or data
The connection
Both compensate the lender for lost interest, often by similar amounts. Yield maintenance is a cash payment, and the loan is retired. Defeasance keeps the loan alive, now backed by Treasuries, because CMBS trusts must keep bond payments intact. Defeasance adds third-party fees but can cost less than the balance when rates have risen.
When and why
Yield maintenance is common in life-company and agency loans; defeasance in CMBS loans since the 1990s.
How we know
Loan documents specify which applies; REMIC tax rules explain why CMBS loans favor defeasance.
Debates and risks
Which costs less in a given case depends on the yield curve and fees at exit, so owners often compare quotes before choosing a loan.