What is yield maintenance?
Yield maintenance is a prepayment premium that pays the lender the interest it loses when you repay a fixed-rate loan early, measured against current Treasury yields. If your note rate is above the Treasury yield for the remaining term, the premium is roughly the rate difference times the balance, discounted back to today. If Treasury yields have risen above your rate, most loans fall back to a minimum premium.
Fannie Mae’s standard prepayment premium schedule shows the formula. The premium is the greater of 1% of the principal being prepaid or the product of three numbers: the amount prepaid, the fixed rate minus the Yield Rate, and a present value factor for the months left until the Yield Maintenance Period End Date.
How yield maintenance is calculated
Yield maintenance equals the prepaid balance times the rate spread times a present value factor. In Fannie Mae’s schedule, the Yield Rate is interpolated from the Treasury constant maturities published in the Federal Reserve’s H.15 release, measured on the 25th business day before the intended prepayment date. The factor is [1 − (1 + r)^(−n/12)] ÷ r, where r is the Yield Rate and n is the months remaining in the yield maintenance period.
- Prepaid balance: the principal you pay off at closing.
- Spread: your note rate minus the Treasury Yield Rate. A wider spread means a bigger premium.
- Time remaining: months left until the yield maintenance period ends, not until maturity.
- Floor: the minimum premium in the loan, 1% of principal on Fannie Mae’s standard schedule.
- End date: Fannie Mae’s schedule charges no premium on or after the Yield Maintenance Period End Date.
What is defeasance?
Defeasance releases the lien on your property by replacing it with Treasury securities whose payments cover every remaining loan payment. The loan isn’t paid off. It stays in the securitization, and a successor borrower takes over the loan and the securities, so you can sell the building free and clear.
Securitized loans, especially CMBS, use defeasance because they often sit in REMIC trusts. Under Treasury Regulation 1.860G-2(a)(8), a REMIC can release its lien in a defeasance only if the substitute collateral consists solely of government securities, the loan documents allow the substitution, the release is for a sale or other customary commercial transaction, and the release is not within two years of the REMIC’s startup day. That rule is one reason securitized loans often lock out prepayment at the start.
How defeasance works, step by step
A defeasance runs alongside your sale and usually closes the same day. A defeasance consultant typically manages it for the borrower. The usual steps:
- Give the servicer written notice of the defeasance by the deadline in your loan documents.
- Hire a defeasance consultant and a securities broker to price the Treasury portfolio.
- The consultant builds a portfolio of Treasury securities whose cash flows match each remaining payment and the balloon.
- An independent accountant verifies that the securities cover the payments.
- A successor borrower, usually a special-purpose entity, assumes the loan and pledges the securities.
- The servicer releases the mortgage, and your sale closes free of the loan.
What does defeasance cost?
Defeasance costs the price of the Treasury portfolio minus your loan balance, plus transaction fees. When Treasury yields are lower than your note rate, the securities cost more than the balance, and that premium is the main expense. When yields are higher than your rate, the portfolio can cost less than the balance, which is the one case where defeasance can beat a loan with a yield maintenance floor.
The fees come on top: the defeasance consultant, the successor borrower, the accountant’s verification, servicer and rating agency charges where required, and legal fees for both sides. Get a written quote early. Treasury prices move every day, and the final cost isn’t locked until shortly before closing.
Defeasance vs yield maintenance: key differences
Yield maintenance is a cash penalty you pay to retire the loan, while defeasance keeps the loan alive and replaces your building with Treasuries. Both rise when rates fall and shrink when rates rise. The practical differences are complexity, timing and the minimum cost.
| Yield maintenance | Defeasance | |
|---|---|---|
| What happens to the loan | Paid off | Stays outstanding with a successor borrower |
| What you pay | Cash premium to the lender | Cost of Treasury portfolio plus fees |
| Minimum cost | Often a floor, such as 1% of principal | No floor; portfolio can cost less than par when yields rise |
| Typical loans | Agency loans, bank loans, some CMBS | CMBS and many securitized agency loans |
| Third parties | Lender or servicer | Consultant, broker, accountant, successor borrower |
| Timing | Notice period, then payoff | Notice period, portfolio purchase and closing on the same day |
Worked example: a $6 million loan four years before maturity
Say your apartment building has a $6,000,000 loan at 5.25% on a 25-year remaining amortization, with 48 months left until the yield maintenance period ends and the loan matures. The monthly payment is $35,954.86, and the balloon at maturity would be $5,482,896. The interpolated four-year Treasury yield is 4.00%.
Yield maintenance: the spread is 1.25%. The present value factor is [1 − 1.04^(−4)] ÷ 0.04 = 3.6299. The premium is $6,000,000 × 0.0125 × 3.6299 = $272,242, or 4.54% of the balance. That is above the 1% floor of $60,000, so you’d owe $272,242.
Defeasance: a Treasury portfolio that pays the 48 monthly payments and the balloon, priced at a 4.00% yield, costs about $6,265,858. That’s $265,858 above the balance, before consultant, accountant, successor borrower and legal fees. Once those fees are added, the two approaches land close together.
Now flip the rate. If the Treasury yield were 5.50%, above your 5.25% note rate, the yield maintenance formula would go negative and you’d pay the $60,000 floor. A Treasury portfolio priced at 5.50% would cost about $5,948,354, roughly $51,646 less than the balance, before fees.
| Item | Yield maintenance | Defeasance |
|---|---|---|
| Loan balance | $6,000,000 | $6,000,000 |
| Treasury yield used | 4.00% | 4.00% |
| Premium or excess cost | $272,242 | $265,858 |
| Plus transaction fees | Minimal | Consultant, accountant, successor borrower, legal |
| If Treasury yield is 5.50% | $60,000 floor (1%) | About $5,948,354 before fees |
Step-down prepayment penalties
A step-down prepayment penalty is a fixed percentage of the balance that declines each year, such as 5%, 4%, 3%, 2% and 1%. It doesn’t move with interest rates, so you can know the cost years ahead. On the $6,000,000 loan above, a 3% step-down year would cost $180,000 and a 1% year would cost $60,000.
Bank and bridge lenders often use step-downs. They usually come with a slightly higher interest rate, because the lender gives up protection if rates fall.
Lockouts and open periods
A lockout is a stretch when you can’t prepay at all, and an open period is a window near maturity when you can prepay at par with no premium. Securitized loans often have a lockout at the start, tied to the REMIC two-year rule for defeasance. Many fixed-rate loans then open in the final months before maturity.
On Fannie Mae’s standard schedule, no premium is due on or after the Yield Maintenance Period End Date, which falls before the maturity date. Check the exact dates in your note. If your open period starts a few months after your planned closing, moving the closing date can save six figures.
Loan assumption as an alternative to the penalty
A loan assumption avoids yield maintenance and defeasance entirely, because the loan isn’t prepaid. The buyer takes over the note, and you pay or split a transfer fee, often 1% on agency loans, instead of a prepayment premium. In the example above, a 1% fee on $6,000,000 is $60,000, compared with roughly $266,000 to $272,000 to prepay.
Assumption is easiest to sell when your rate is at or below market, because the buyer gets cheap debt. When your rate is above market, the penalty is biggest but buyers want the loan less, so expect to negotiate on price or on who pays the fee. The buyer has to qualify with the lender, and you should ask for a release of liability. Our assumable mortgage guide covers the process.
How prepayment penalties affect a 5+ unit apartment sale
On an apartment building, the prepayment penalty comes straight out of your net proceeds, so price it before you list. Compare three paths: prepay or defease and sell for cash, offer the loan for assumption, or wait for a lower step-down year or the open period. Each one changes your proceeds and your timing.
Taxes run alongside the loan math. Your gain, depreciation recapture and any 1031 exchange deadlines don’t change because of the penalty, but the penalty changes how much cash you have to reinvest. Have your CPA run the after-tax numbers for each path before you sign a contract.
Selling a building with a prepayment penalty to Skyline
Skyline Capital Investments buys apartment buildings with five or more units nationwide. We underwrite loan assumptions, work around open-period dates and can offer seller-carry terms, and we work with 1031 exchange timelines. Send the address, unit count and your loan’s rate, balance and prepayment terms through the form on this page or call (469) 660-2977. We typically respond within 48 hours.
