What is defeasance cost?

Defeasance, as its name suggests, is a method for reducing the fees required when a borrower decides to prepay a fixed-rate commercial real estate loan. Instead of paying cash to the lender, the defeasance option allows the borrower to exchange another cash-flowing asset for the original collateral on the loan.

Is defeasance a prepayment penalty?

In some cases, the borrower will be required to pay the entire remaining interest on the note at the time that the debt is repaid. However, in many instances, the terms of the loan will call for a defeasance, which is effectively a prepayment penalty, but that can offer some flexibility to the borrower.

What is the difference between yield maintenance and defeasance?

Yield maintenance is the actual prepayment of the loan, while defeasance entails a substitution of collateral and a legal assumption of the loan by the successor borrower. A yield maintenance prepayment has two components: the unpaid principal balance of the loan and a prepayment penalty.

What is defeasance in CMBS?

Defeasance Explained Most often used in commercial real estate as the prepayment penalty on conduit/CMBS loans, defeasance is the process of releasing a commercial property from the lien of the mortgage and replacing it with a portfolio of U.S. government securities.

How does a defeasance work?

The defeasance process is a means by which borrowers can get out of a mortgage by substituting a portfolio of U.S. Treasury-backed securities for collateral. In the case of defeasance, the debt obligation does not go away, but the defeasance releases the mortgaged property from the lien against it.

What is a prepayment clause?

A prepayment penalty clause states that a penalty will be assessed if the borrower significantly pays down or pays off the mortgage, usually within the first five years of the loan. Prepayment penalties serve as protection for lenders against losing interest income.

Is a loan prepayment penalty tax deductible?

To deduct the entire prepayment penalty in one year, you must pay the penalty in full. If you refinance and roll the penalty into your new loan, you can deduct the penalty over the life of the loan. For borrowers who refinance but choose to pay the prepayment penalty at closing, the entire penalty is deductible.

Is a prepayment penalty tax deductible?

Mortgage prepayment penalty. You can deduct that penalty as home mortgage interest provided the penalty isn’t for a specific service performed or cost incurred in connection with your mortgage loan.

How is maintenance yield calculated?

Yield maintenance is intended to mitigate lenders’ prepayment risk, or to discourage borrowers from settling their debts ahead of schedule. The formula for calculating a yield maintenance premium is: Yield Maintenance = Present Value of Remaining Payments on the Mortgage x (Interest Rate – Treasury Yield).

How is spread maintenance calculated?

Spread Maintenance Payment means a payment to Lender in an amount equal to the outstanding principal balance immediately prior to a prepayment under the last paragraph of Section 2.3. 1 hereof, multiplied by 2.5%, divided by 12 and multiplied by the number of months remaining in the Lockout Period.

What is a notice of defeasance?

Defeasance is a provision in a contract that voids a bond or loan on a balance sheet when the borrower sets aside cash or bonds sufficient enough to service the debt.

What does defeasance date mean?

More Definitions of Defeasance Date Defeasance Date means the date on which all the Bonds shall have been paid and discharged or shall be deemed paid and discharged for purposes of and in accordance with the Indenture, and the Indenture shall have be with its terms.

Is the defeasance premium paid as a deductible?

A defeasance premium paid under a legal defeasance is deductible as a payment of interest in the year incurred. The transactional steps of a typical legal defeasance are listed below.

How does defeasance reduce commercial real estate loan fees?

What are the costs of a defeasance transaction?

Borrowers must pay legal fees, accountant fees, and successor borrower fees to commence a defeasance transaction. Generally, the borrower must weigh the costs of the defeasance against the benefits of a lower interest rate on the refinancing plus additional cash flow from the refinancing or proceeds from a sale and make an economic decision.

How much does it cost to have a defeasance consultant?

Defeasement Consultant’s Role & Players in the Process The cost of these parties, shouldered by the borrower, can run from $50,000 to upwards of $100,000. Thankfully, the cost of the defeasance is tax deductible, so long as the deduction is claimed in the year of the defeasance.