Both yield maintenance and defeasance allow borrowers to unencumber the underlying real estate asset. However, from a legal and economic perspective, the two processes are fundamentally different. Yield maintenance is the actual prepayment of the loan, while defeasance entails a substitution of collateral and an assumption of the loan by the Successor Borrower.
A yield maintenance prepayment usually consists of two portions: the loan’s unpaid principal balance and a prepayment penalty. The prepayment penalty typically is determined by calculating the Present Value of the remaining loan payments, with a discount factor equal to the current yield on the U.S. Treasury that matures closest to the loan’s maturity date. The only transaction fee is a small processing fee to the Loan Servicer.
In contrast, the cost of defeasance is determined by the price of a portfolio of bonds that are sufficient to provide for the remaining loan payments, plus transaction fees to several third parties.
For borrowers, yield maintenance is generally simpler and less time-consuming than defeasance.