CMBS Loans and Prepayment
If you take out a CMBS loan, and you want to pay off the loan early, perhaps because you’re selling the property, you’ll usually have to pay a prepayment penalty. Prepayment penalties are designed to compensate the lender, or, in the case of conduit loans, the investors, for the loss of income that will result from a borrower paying off their loan early.
How Conduit Loan Prepayment Actually Works
Prepayment penalties for CMBS loans are typically structured as either yield maintenance or defeasance. Yield maintenance involves paying off the balance of the loan, plus a specific percentage of the loan amount, often 1-3%. In comparison, defeasance allows a borrower to replace their debt with similar securities, usually bonds, in order to compensate investors. Most CMBS loan agreements restrict eligible bond types to agency bonds, such as Freddie Mac or Fannie Mae bonds, or U.S. Treasury bonds. U.S. Treasury bonds are typically more expensive than agency bonds, so borrowers using defeasance will usually opt to prepay their loan with agency bonds when possible.