Yield maintenance is a prepayment premium on a fixed-rate commercial real estate loan that compensates the lender for the interest lost when the loan is repaid before maturity. The premium is the present value of the difference between the note rate and a reference Treasury yield on the remaining payments, discounted at the reference rate, subject to a minimum.
How is yield maintenance calculated?
In words:
Yield maintenance premium = the present value, discounted at the reference Treasury yield, of the remaining scheduled principal and interest payments, minus the outstanding principal balance; but never less than the floor.
The same result, stated another way: the note rate minus the reference yield, applied to the scheduled balance for each remaining period, present valued at the reference yield. The floor is commonly a minimum premium expressed as a stated percentage of the prepaid balance, and many documents add a separate par floor so that the borrower always owes at least the full balance.
Illustrative example:
| Input | Reference yield below the note rate | Reference yield above the note rate |
|---|---|---|
| Outstanding balance | $10,000,000 | $10,000,000 |
| Note rate | 6.00%, interest-only, balloon in 5 years | 6.00%, interest-only, balloon in 5 years |
| Reference Treasury yield | 4.00% | 6.50% |
| Rate differential | 2.00% per year, or $200,000 per year | Negative; formula produces zero |
| Present value of the differential at the reference yield | About $890,000 | $0 |
| Floor (1% of the balance) | $100,000 | $100,000 |
| Yield maintenance premium | About $890,000 | $100,000 |
The balance is repaid in both columns; only the premium differs.
Which Treasury is the reference, and when is it observed?
The loan documents specify the reference. The tenor is the Treasury matching the remaining term, a yield interpolated between the two nearest tenors, or a named tenor. Some documents use the Treasury flat; others add a spread to it, which lowers the premium. The observation date is the prepayment date itself or a lookback of a stated number of business days before it, which is common on agency and bank loans. Discounting is monthly or semiannual, and the balloon is included or excluded. Each choice moves the premium. Real-time prepayment calculations covers the conventions in detail.
Why does yield maintenance fall as rates rise and as maturity approaches?
The premium is a function of two things: the gap between the note rate and the reference yield, and the number of payments left. When Treasury yields rise, the gap narrows and the premium falls; when the reference yield reaches the note rate, the formula produces zero and only the floor remains. When yields fall, the gap widens and the premium grows.
As the maturity date approaches, fewer payments remain to be present valued, so the same gap produces a smaller premium every month. On an amortizing loan the scheduled balance also declines, which shrinks the premium further.
How does yield maintenance differ from defeasance and a step-down?
Defeasance is not a payment to the lender. The borrower substitutes a portfolio of Treasury securities that replicates the remaining loan payments, the property is released, and the loan continues to maturity. It is the standard mechanism on CMBS loans, and it takes weeks and a transaction team.
A step-down prepayment is a stated percentage of the balance that declines by loan year on the closing anniversary. It is simple to calculate and has no rate sensitivity, so it is cheap when rates have fallen and expensive when rates have risen relative to yield maintenance on the same loan.
Many loans combine conventions by period: a lockout, then yield maintenance, then a step-down, then an open period. The open period is the final months of the term in which the loan is prepayable at par with no premium; its length is set in the documents. The prepayment date decides which convention applies.
How yield maintenance shows up in LoanBoss
LoanBoss calculates yield maintenance and defeasance in real time, with the ability to project prepayment costs for future dates. Every prepayment convention in the loan documents, including the rate lookback, is reflected in each loan, and the platform alerts before step-downs and calculates the exact prepayment cost for any date.
Frequently Asked Questions
Is yield maintenance the same as a prepayment penalty?
It is one form of prepayment premium. Others are a flat or step-down percentage of the balance, spread maintenance, a make-whole, swap breakage on a hedged floating-rate loan, and defeasance. The loan documents specify which applies in each period.
Can yield maintenance be zero?
The formula produces zero when the reference Treasury yield is at or above the note rate. Most documents then apply a floor, so the borrower owes the stated minimum premium, and the full balance is always due.
What is the open period?
The final months of a fixed-rate loan’s term in which the borrower may prepay at par without a premium. Its length is set in the loan documents, and it is the cheapest date to repay when a refinancing timeline is flexible.
Does a loan assumption trigger yield maintenance?
No. On an assumption the loan stays in place and the buyer takes it over at its existing terms, so no prepayment occurs and no premium is owed. Assumption fees and lender consent still apply.
Which loans carry yield maintenance?
Fixed-rate agency, bank and life company loans commonly use yield maintenance, while CMBS loans commonly use defeasance. Some loans switch from one to the other by period, and the documents govern.
Related Terms
- Defeasance
- Maturity Date
- Amortization
- CMBS
- What Is Yield Maintenance? The Borrower’s Complete Guide
- Yield Maintenance in Your Portfolio: What to Track and When to Act
Part of the LoanBoss CRE Debt Glossary. For hedging-specific terms, see Pensford’s resources.
Sources
- LoanBoss CRE Debt Glossary