A CMBS loan prepayment penalty is a fee that a borrower must pay if they choose to pay off their loan before its maturity date. 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. 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.

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CMBS loan prepayment penalties 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.

When it comes to conduit financing, borrowers can expect to face prepayment penalties — defeasance, yield maintenance, or a step-down prepayment schedule — for loans paid before their maturity date. These prepayment penalties are put in place as a means of dissuading borrowers from paying their loans off early, and, by extension, preventing the bondholders from receiving their scheduled returns. While other financing vehicles also utilize prepayment penalties, CMBS loans are unique in that they typically have prepayment penalties in place for almost the entire term of the loan.

The benefits of a CMBS loan prepayment penalty are that it helps to compensate the lender or investors for the loss of income that will result from a borrower paying off their loan early. Prepayment penalties are also put in place as a means of dissuading borrowers from paying their loans off early, and, by extension, preventing the bondholders from receiving their scheduled returns. CMBS loans are unique in that they typically have prepayment penalties in place for almost the entire term of the loan.

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.

The major downside of CMBS loans is the difficulty of getting out the loan early. Most, if not all CMBS loans have prepayment penalties, and while some permit yield maintenance (paying a percentage based fee to exit the loan), other CMBS loans require defeasance, which involves a borrower purchasing bonds in order to both repay their loan and provide the lender/investors with a suitable source of income to replace it. Defeasance can get expensive, especially if the lender/investors require that the borrower replace their loan with U.S. Treasury bonds, instead of less expensive agency bonds, like those from Fannie Mae or Freddie Mac.

In addition, CMBS loans typically do not permit secondary/supplemental financing, as this is seen to increase the risk for CMBS investors. Finally, it should be noted that most CMBS loans require borrowers to have reserves, including replacement reserves, and money set aside for insurance, taxes, and other essential purposes. However, this is not necessarily a con, since many other commercial real estate loans require similar impounds/escrows.

The best way to avoid a CMBS loan prepayment penalty is to wait until the loan matures before paying it off. According to CMBS.loans, 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.

According to Apartment.loans, while other financing vehicles also utilize prepayment penalties, CMBS loans are unique in that they typically have prepayment penalties in place for almost the entire term of the loan.