Prepayment Penalty
A fee charged to a borrower for paying off a loan before its scheduled maturity date. Prepayment penalties compensate the lender for lost interest income and come in several forms: yield maintenance (present value of lost interest), defeasance (substitution of securities), step-down (declining fixed percentage), and lockout (prohibition on early payment). The type and severity of prepayment penalty varies by lender and loan product, and significantly impacts a borrower's flexibility to sell, refinance, or recapitalize during the loan term.
Related Terms
Yield Maintenance
A prepayment penalty calculated to compensate the lender for lost interest income, typically the present value of the difference between the note rate and current Treasury yields for the remaining loan term. Yield maintenance can be very expensive in rising rate environments. Some loans offer "declining" yield maintenance that reduces over time.
Defeasance
A prepayment method where the borrower purchases a portfolio of government securities that generates cash flows matching the remaining loan payments. The securities are assigned to the lender, and the property is released from the mortgage. Defeasance is required for most CMBS loans and can be expensive, especially when interest rates rise.
CMBS (Commercial Mortgage-Backed Securities)
Loans originated by conduit lenders that are pooled together and sold to investors as bonds. CMBS loans offer higher leverage (up to 75% LTV) with competitive rates across all property types. They feature standardized terms, non-recourse execution, and are assumable. However, they have significant prepayment restrictions (defeasance or yield maintenance) and less flexibility than portfolio loans.
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