A prepayment penalty on a commercial real estate loan is the charge a borrower pays to repay principal before the documents allow it for free, set by one of six conventions (lockout, step-down percentage, yield maintenance, make-whole, defeasance or spread maintenance) that respond differently to interest rates and to the passage of time. Picking the type at origination is a bet on rates and on the hold period. A borrower who accepts the lender’s default places that bet without pricing it, and learns what it cost at the sale or refinance.
The six types side by side
| Type | How the cost is set | What moves it |
|---|---|---|
| Lockout | No prepayment permitted until a date | Time only |
| Step-down (declining premium) | A percentage of the balance that falls by loan year | Time only |
| Yield maintenance | Present value of the note rate less a Treasury yield over the remaining term, usually with a 1% minimum | Rates and time |
| Make-whole | Present value of remaining payments at a Treasury-plus-spread rate, less the balance | Rates and time |
| Defeasance | Cost of government securities that replicate the remaining payments, less the balance, plus fees | The whole curve and time |
| Spread maintenance | The loan spread for the months left in the maintenance period | Time only |
Two further items sit on top of these. Swap breakage applies when the loan is hedged with a swap, and aggregate interest provisions charge any shortfall against a minimum interest amount. Many loans also combine types by period: lockout, then yield maintenance, then a step-down, then an open period. The mechanics of each convention, and why estimates of them go wrong, are in real-time prepayment calculations. The question here is which type costs what, and when.
Where each type shows up
Agency. Fannie Mae’s fixed-rate term sheet allows voluntary prepayment on payment of yield maintenance or a prepayment premium, and its declining premium option is available on fixed-rate, structured ARM and hybrid ARM loans. See managing agency loans.
CMBS. Lockout followed by defeasance is the dominant pattern, but not the only one. In one 2020 conduit, GS Mortgage Securities Trust 2020-GSA2, some loans instead allow prepayment with the greater of yield maintenance and a 1% premium, and the 711 Fifth Avenue loan permits defeasance only after a lockout that ends on the earlier of two years after the last related securitization closes or a fixed date. See defeasance decisions in portfolio context.
Banks and LifeCos. Step-downs, yield maintenance and make-whole variants, often with swap breakage on hedged loans. See LifeCo loans.
Debt funds and bridge lenders. Spread maintenance on floating-rate loans, for a set number of months after closing.
Step-down penalties and step-down loans
A step-down prepayment penalty charges a fixed percentage of the balance that declines each loan year, and loans with this structure are often called step-down loans. Fannie Mae’s declining prepayment premium term sheet lists the schedules for fixed-rate loans:
| Loan term | Schedule by loan year | Lockout |
|---|---|---|
| 5 years | 5-4-3-2-1 | None |
| 7 years | 5-4-3-2-1 | 2 years |
| 10 years | 5-5-4-4-3-3-2-2-1-1 | None |
| 12, 15, 18 or 30 years | 5% in years 1 to 4 (years 1 to 7 for 15, 18 and 30 years), then one point lower every two years, 1% to maturity | None |
The step-down is the only fixed-rate convention whose cost does not depend on rates. That makes it the cheaper exit when Treasury yields have fallen far enough below the coupon, and the dearer one when rates have risen and yield maintenance has dropped to its floor. The trap is the date: each step falls at the end of a loan year as the note defines it, not on January 1, and Fannie Mae’s form note allows a payoff only on the last business day before a scheduled payment date, so a payoff one payment date too early can cost a full point.
A worked example: one loan, four conventions
A $10,000,000 interest-only loan at 5.50%, ten-year term, prepaid after four years with 72 months remaining. The flat Treasury yield on the payoff date is one of four values. The step-down follows the 10-year schedule above, so loan year five charges 3%.
Illustrative example: prepayment cost on the same loan under four conventions (flat Treasury curve, fees excluded)
| Treasury yield at payoff | Step-down, 3% | Yield maintenance, Treasury flat, 1% floor | Make-whole, Treasury + 0.50%, no floor | Defeasance, securities cost less balance |
|---|---|---|---|---|
| 3.50% | $300,000 | $1,080,960 | $798,968 | $1,080,960 |
| 4.50% | $300,000 | $524,966 | $258,720 | $524,966 |
| 5.50% | $300,000 | $100,000 (floor) | $0 | $0 |
| 6.50% | $300,000 | $100,000 (floor) | $0 | ($495,739) |
How the figures are built. Yield maintenance at 3.50% is the monthly rate difference, ($10,000,000 × 2.00%) / 12 = $16,666.67, discounted over 72 months at 3.50% (an annuity factor of 64.8576), which gives $1,080,960. At 4.50% the difference halves to $8,333.33 and the factor is 62.9960, giving $524,966. At 5.50% and above the formula returns zero or less, so the 1% floor of $100,000 applies. Make-whole discounts the loan’s own payments, $45,833.33 of interest a month plus the $10,000,000 balloon, at the Treasury yield plus 0.50%: at 3.50% that present value is $10,798,968, so the charge is $798,968, and at Treasury yields of 5.00% and above it falls to zero. Defeasance prices the same payments at the Treasury yield itself: $11,080,960 at 3.50% and $9,504,261 at 6.50%, which is $495,739 below the balance before fees.
Three readings from the table:
- With a flat curve and no floor, yield maintenance and defeasance are the same number. In practice they diverge because of the floor, the shape of the curve, the securities actually bought and the legal, accounting and consultant fees that come with a defeasance.
- A spread added to the discount rate lowers the cost. The make-whole at Treasury plus 0.50% costs $281,992 less than Treasury-flat yield maintenance at 3.50%. The discount rate definition is worth negotiating. See what is yield maintenance.
- The step-down wins only when rates fall. At 3.50% it saves $780,960 against yield maintenance; at 5.50% and above it costs $200,000 more than the floor.
Spread maintenance works on a different loan. A $10,000,000 floater at SOFR plus 3.00% with 18 months of spread maintenance, repaid in month 12, owes the spread for the six months left: 6 × ($10,000,000 × 3.00% / 12) = $150,000 before discounting. Rates do not change that number. The calendar does.
Choosing the type at origination
- Match the type to the likely exit. A step-down fixes the exit cost in advance and wins if Treasury yields fall far enough below the coupon; yield maintenance costs less if rates rise, down to its floor. The hold period decides which percentage on the schedule applies.
- Negotiate the details as well as the type. The Treasury tenor, any spread in the discount rate, the floor, the lookback and the length of the open period each change the number.
- Keep an assumption path. A loan a buyer can assume avoids the penalty on a sale. See commercial loan assumption.
- Check partial prepayment rights. Paying down to cure a covenant is only possible if the documents allow it, and the penalty usually applies to the amount prepaid.
The 2020-GSA2 prospectus also warns bondholders that prepayment premiums, yield maintenance and lockouts may not be enforceable in some states or in bankruptcy. For a borrower planning an ordinary sale or refinance, the documents govern.
What to track across a portfolio
- The convention by period for every loan, with the date each period ends.
- Step-down anniversaries and open period starts as critical dates with alerts. See loan critical date tracking.
- The prepayment cost today and on each planned exit date, refreshed as the curve moves.
- Which loans are rate-sensitive (yield maintenance, make-whole, defeasance) and which are time-only (step-down, spread maintenance), so a rate move is read as a change in exit cost.
- The prepayment line in every refinance comparison. See commercial real estate refinance.
How this looks in LoanBoss
Every prepayment type (lockout, flat percentage, aggregate interest, spread maintenance, yield maintenance, make-whole, swap breakage and defeasance) is modeled per loan and per period, including the rate lookback. LoanBoss alerts before step-downs and calculates the exact prepayment cost for any date, with yield maintenance and defeasance computed in real time and projectable to future dates.
Frequently Asked Questions
What is the most common prepayment penalty on commercial loans?
It depends on the lender. CMBS loans mostly use lockout followed by defeasance, some with yield maintenance instead, agency fixed-rate loans use yield maintenance or a declining premium, and debt fund floaters use spread maintenance. Many loans combine two or more by period.
What is a step-down prepayment penalty?
A fixed percentage of the balance that declines by loan year, such as 5-4-3-2-1 on a five-year loan. The cost does not depend on interest rates, and each step falls at the end of a loan year as the note defines it.
Is yield maintenance cheaper than defeasance?
With a flat curve and no floor the two produce the same figure. In practice yield maintenance is a cash payment with a floor, while defeasance carries fees and can price below the balance when rates are above the coupon. Compare both on the payoff date.
When does yield maintenance hit its floor?
When the reference Treasury yield is at or above the note rate, the formula returns zero or less and the minimum, usually 1% of the balance, applies.
Can a prepayment penalty be avoided on a sale?
Yes, if a buyer assumes the loan, or if the sale closes in the open period. Otherwise the penalty is a transaction cost that belongs in the sale model.
Key takeaways
- Six conventions set commercial prepayment penalties, and they split into time-only types (lockout, step-down, spread maintenance) and rate-sensitive types (yield maintenance, make-whole, defeasance).
- A step-down costs the same at any rate; it is the cheaper exit when rates fall far enough and the dearer one when they rise.
- Yield maintenance and defeasance match under a flat curve with no floor; the floor, curve shape and fees separate them.
- The discount rate definition, floor, lookback and open period are negotiable and each changes the cost.
- Step-down anniversaries and open period dates belong on the critical date schedule.
Related reading
- What is yield maintenance?
- Real-time prepayment calculations
- Defeasance decisions in portfolio context
- Commercial real estate refinance
- Commercial loan assumption
- Yield maintenance and defeasance in the glossary
The prepayment type was chosen at closing. LoanBoss prices it on every date between now and the exit.
Sources
- Fannie Mae Multifamily, Declining Prepayment Premium Term Sheet (2026)
- Fannie Mae Multifamily, Fixed-Rate Mortgage Loans Term Sheet (2026)
- GS Mortgage Securities Trust 2020-GSA2, preliminary prospectus (Form 424H), SEC EDGAR (2020)