What is the difference between defeasance and yield maintenance? Defeasance and yield maintenance are the two main prepayment penalties on fixed-rate commercial real estate loans, and both exist to make the lender whole when a borrower pays off a loan before maturity. Yield maintenance is a cash penalty roughly equal to the present value of the lender's lost interest; defeasance replaces the property as collateral with a portfolio of government securities that reproduces the loan's remaining payments. Using AI to choose between them means modeling the cost of each exit across interest rate scenarios and remaining terms, so a borrower can pick the cheaper path and time a sale or refinance to minimize the penalty. This exit math is a core part of our complete guide to AI CRE finance and capital markets.
Key Takeaways
- Yield maintenance is a cash payment equal to the present value of the lender's lost interest, usually subject to a floor of about 1 percent of the prepaid balance.
- Defeasance substitutes a portfolio of government securities for the property as collateral, and its cost is the price of those securities above the loan balance plus transaction fees.
- The economic core of both penalties is the same present value of the rate gap, so when both are available the deciding factors are transaction costs, the yield maintenance floor, and the loan documents.
- Both penalties are most expensive when rates have fallen since origination and the loan has a long remaining term, and both shrink sharply as rates rise toward the note rate.
- AI models both exit costs across rate and timing scenarios at once, revealing the crossover point where defeasance becomes cheaper than yield maintenance or where waiting to prepay saves the most.
Yield Maintenance and Defeasance, Defined
Yield maintenance is the simpler of the two. When a borrower prepays, the lender calculates the interest it expected to receive over the remaining term, compares it to what it can now earn by reinvesting the prepaid principal at a comparable-maturity Treasury yield, and charges the borrower the present value of the shortfall. The penalty is almost always subject to a floor, commonly 1 percent of the prepaid balance, so the lender receives at least a minimum even if rates have risen. Yield maintenance is a single cash payment, and the loan is then retired.
Defeasance does not retire the loan at all. Instead, the borrower buys a portfolio of government securities, typically Treasuries or agency bonds, structured so that the securities' principal and interest payments exactly replicate the loan's remaining scheduled payments. Those securities are pledged as substitute collateral, the property is released, and the loan continues to be paid by the securities through to maturity. This structure is standard in CMBS because it keeps the loan and its cash flows intact for the bondholders. The cost of defeasance is the price of buying that replacement portfolio, plus transaction costs for the defeasance consultant, accountant, attorneys, and successor borrower, which commonly run from fifty thousand to well over one hundred thousand dollars.
What Drives Which One Is Cheaper
The single biggest driver of both penalties is the relationship between the loan's note rate and current Treasury yields. When Treasury yields are well below the note rate, the lender's reinvestment shortfall is large, so yield maintenance is high, and the replacement securities for defeasance cost far more than the loan balance, so defeasance is high too. When Treasury yields rise toward or above the note rate, the shortfall shrinks, yield maintenance can fall to its floor, and the defeasance portfolio can be bought for close to, or even below, the loan balance. Remaining term amplifies everything: the longer the time to maturity, the more payments are being valued, so penalties on a loan with six years left dwarf those on a loan with eighteen months left.
This is why a borrower's exit cost can swing dramatically with rates, and why timing matters. The same loan that is prohibitively expensive to prepay when rates are low can become cheap to exit after rates rise, an effect every borrower with maturing debt should model rather than guess at. The mechanics overlap heavily with our guide to AI interest rate sensitivity analysis for CRE, because the penalty is, at heart, a bet on where rates sit relative to your note.
A Worked Comparison You Can Verify
Consider a twenty-five million dollar CMBS loan fixed at 5.5 percent, interest-only, with four years remaining, where both exit options are available. Suppose the comparable four-year Treasury yield is 4.5 percent. For yield maintenance, the lost spread is 5.5 percent minus 4.5 percent, or 1.0 percent of twenty-five million, which is two hundred fifty thousand dollars a year for four years. Discounted at 4.5 percent, that stream has a present value of roughly nine hundred thousand dollars, comfortably above the 1 percent floor, so yield maintenance governs at about nine hundred thousand dollars.
For defeasance in the same scenario, the replacement securities must reproduce the loan's payments, twenty-five million in principal at year four plus interest at 5.5 percent, but they only yield 4.5 percent, so they cost more than the loan balance. The premium works out to roughly the same nine hundred thousand dollars, because both penalties are fundamentally the present value of the same one percent rate gap. Add defeasance transaction costs of, say, ninety thousand dollars, and defeasance totals about nine hundred ninety thousand dollars versus nine hundred thousand for yield maintenance. In this scenario yield maintenance is cheaper by roughly the transaction cost. Now flip the scenario: if Treasury yields rise to 5.5 percent, the defeasance premium falls toward zero, leaving mostly the ninety thousand dollars of fees, while yield maintenance drops only to its 1 percent floor of two hundred fifty thousand dollars. At that point defeasance is far cheaper. The crossover is real, and it is exactly what AI is built to find.
How AI Models Both Exits
The calculations above are simple in a single scenario and unwieldy across many, which is the case for AI. Give a model the loan balance, note rate, amortization, remaining term, and the current Treasury curve, and it computes both the yield maintenance penalty, including the floor, and the defeasance cost, including transaction fees. Then have it sweep the inputs: run the cost of each exit at a range of Treasury yields and at several prepayment dates between now and maturity. The output is a grid showing which option is cheaper under which conditions and how much the penalty falls if the borrower waits six or twelve months for an expected rate move.
That timing dimension is where the analysis pays off, because the penalty is often a large enough number to change a sale or refinance decision entirely. Modeling the exit cost alongside the new financing is essential, which is why this pairs naturally with our guide to AI refinancing analysis and refi timing: the penalty is one side of the ledger and the savings from new debt are the other. Sponsors who want both sides modeled together on every loan can work with The AI Consulting Network to build the workflow, and Avi Hacker, J.D. helps borrowers turn an opaque prepayment clause into a clear, dated decision.
Fitting the Exit Decision Into the Portfolio
For an owner with multiple loans, the prepayment penalty is not a single-deal question but a portfolio one. Which loan should be refinanced or sold first depends partly on which carries the cheapest exit at today's rates, and that ranking shifts as rates move and as each loan approaches maturity, where penalties typically phase out in an open prepayment window. Layering the defeasance and yield maintenance math onto a maturity ranking turns a list of due dates into a prioritized action plan, the approach behind our guide to the AI CRE loan maturity portfolio prioritization.
Two practical cautions belong on every analysis. First, the loan documents control: some loans permit only defeasance, some only yield maintenance, and many specify lockout periods during which no prepayment is allowed at any price, so the available options must be read from the actual documents before any modeling. Second, the numbers above are illustrative and depend on the exact reinvestment convention and security pricing the loan specifies, so treat the AI output as a rigorous first pass to confirm with the servicer and a defeasance consultant. For broader context on commercial mortgage and CMBS market conditions, the Mortgage Bankers Association publishes regular research on lending and maturities.
Frequently Asked Questions
Q: Is defeasance or yield maintenance usually cheaper?
A: It depends on rates and costs. The economic core of both is the present value of the gap between your note rate and current Treasury yields, so they are often close. Yield maintenance tends to win on shorter remaining terms because it has no transaction costs, while defeasance can be much cheaper once rates rise toward the note rate, since yield maintenance still owes its floor.
Q: What is the yield maintenance floor?
A: Most yield maintenance clauses include a minimum penalty, commonly 1 percent of the prepaid balance, so the lender receives at least that amount even if rising rates would otherwise reduce the calculated penalty to near zero. This floor is a key reason defeasance can beat yield maintenance in a higher-rate environment.
Q: Can I choose between defeasance and yield maintenance?
A: Only if the loan documents allow it. Many CMBS loans require defeasance and do not offer yield maintenance, while other loans specify yield maintenance. Always confirm which options your specific loan permits, and check for any lockout period that bars prepayment entirely, before modeling the cost.
Q: How does AI help with prepayment penalty decisions?
A: AI computes both penalties across a range of interest rate scenarios and prepayment dates, then shows which exit is cheaper and how much waiting for a rate move could save. It also models the penalty alongside the new financing, so the exit cost is weighed against the benefit of refinancing rather than viewed in isolation.