Navigating Commercial Mortgage Prepayment Options: Defeasance, Yield Maintenance, and Graduated Payment Plans

When it comes to commercial mortgage prepayment options, borrowers often find themselves faced with a variety of choices that can impact their financial obligations. Understanding the different methods available can help borrowers make informed decisions that align with their long-term goals. In this post, we will explore three common commercial mortgage prepayment options: Defeasance, Yield Maintenance, and Graduated Payment Plans.

Defeasance

Defeasance is a method used by borrowers to replace the collateral securing a loan with other assets, typically government securities. By doing so, the borrower is released from their mortgage obligation, effectively prepaying the loan. This option is often chosen when a borrower wants to sell their property but is subject to a lockout period or faces high prepayment penalties.

Key Points about Defeasance:

• Requires the borrower to purchase government securities to replace the collateral.
• Typically results in lower prepayment penalties compared to other options.
• Can be a complex process that involves legal and financial considerations.

Yield Maintenance

Yield Maintenance is a prepayment option that ensures the lender receives the same yield as if the borrower had made all scheduled mortgage payments until maturity. This option is designed to protect the lender's expected yield and can result in significant prepayment penalties for the borrower.

Key Points about Yield Maintenance:

• Calculations are based on the current market interest rates.
• Results in higher prepayment penalties compared to Defeasance.
• Provides certainty to the lender regarding their expected returns.

Graduated Payment Plans

Graduated Payment Plans allow borrowers to make lower initial payments that gradually increase over time. This option is beneficial for borrowers who anticipate an increase in cash flow in the future or want to manage their cash flow more effectively during the early years of the loan.

Key Points about Graduated Payment Plans:

• Payments increase at predetermined intervals over the loan term.
• Provide flexibility for borrowers with changing financial circumstances.
• May result in higher total interest payments over the life of the loan.

Choosing the right commercial mortgage prepayment option requires careful consideration of the financial implications and long-term goals of the borrower. By understanding the differences between Defeasance, Yield Maintenance, and Graduated Payment Plans, borrowers can make informed decisions that align with their unique circumstances.