Prepayment/Yield Maintenance

If you are refinancing a commercial mortgage, the single biggest number you have not yet priced in is usually the prepayment penalty. Borrowers focus on the new rate and forget that paying off the old loan early can trigger a charge that wipes out a year of interest savings — sometimes more. Two penalty structures dominate commercial lending: yield maintenance (a mathematical “make-whole” designed to leave the lender indifferent) and defeasance (buying replacement bonds), plus simpler step-down or percentage schedules on bank and agency loans.

This guide explains how each structure works, how the penalty is calculated, when it applies, and how to model it before you pull the trigger on a refinance. Pair it with our commercial mortgage refinancing guide for the full refi playbook, and run your deal through our yield maintenance calculator to get an exact penalty figure.

What Prepayment Penalties and Yield Maintenance Actually Are

A prepayment penalty is a fee a lender charges when you pay off all or part of a commercial loan before its scheduled maturity. Lenders impose them because they underwrote the loan expecting a predictable stream of interest income over a fixed term; an early payoff forces them to reinvest the principal at prevailing (often lower) rates.

Yield maintenance is the most borrower-unfriendly version. It is a make-whole clause: the penalty is set so the lender earns exactly what it would have received had you made every scheduled payment through the lockout or to a defined “yield maintenance end date.” Unlike a flat fee, yield maintenance moves inversely with interest rates — when rates fall (your incentive to refinance), the penalty rises, because the gap between your loan rate and the reinvestment rate widens.

Quick example. Suppose you have a $1,000,000 loan at 5.75% with 5 years of yield-maintenance protection remaining, and comparable Treasuries yield 4.00%. The penalty approximates the present value of the ~1.75% annual spread over those 5 years — roughly $80,000–$95,000 depending on the exact Treasury yield used and the calculation method in your note. If Treasuries were instead at 5.50%, that same penalty would collapse to near zero. The penalty is a creature of the rate environment, not a fixed cost.

The alternative you will see on CMBS and some life-company loans is defeasance: rather than paying a cash penalty, you buy a portfolio of government securities whose coupon payments replicate the loan’s remaining cash flows, and those bonds serve as the new collateral. Defeasance has third-party costs (advisor, legal, securities) but, unlike yield maintenance, it can sometimes be cheaper when rates have risen.

How to Calculate a Yield Maintenance Penalty

The textbook yield maintenance formula is:

> YM = PV × (Loan Rate − Treasury Yield) × Remaining Yield Maintenance Period

where PV is the present value of that rate differential, discounted back at the Treasury yield. In plain terms:

1. Find your loan’s annual interest that would have been paid during the protected window.
2. Subtract what the lender could earn reinvesting that principal at the comparable Treasury rate.
3. Discount that lost interest back to today’s dollars.

Lenders use the yield on a U.S. Treasury whose maturity roughly matches the remaining loan term (or the yield-maintenance end date) as the reinvestment rate. That is why the penalty explodes when the spread between your loan rate and Treasuries is large.

Most promissory notes add a minimum penalty (often 1% of the outstanding balance, sometimes called a “1% prepayment fee”) so the lender always collects something even if the mathematical make-whole rounds to zero. Read the prepayment section of your note carefully — the formula, the Treasury benchmark, and the lockout period are all defined there.

Worked example. $2,000,000 balance, 6.00% note rate, 3 years of yield maintenance remaining, 3-year Treasury at 4.25%. Annual spread = 1.75%. Approximate lost interest before discounting ≈ $2,000,000 × 1.75% × 3 ≈ $105,000; discounted to present value, expect roughly $95,000–$100,000. Our yield maintenance calculator produces the exact figure for your loan, including the step-down comparisons.

Step-Down and Percentage Schedules (Simpler, Friendlier)

Not every loan uses yield maintenance. Many bank portfolio loans, agency loans (Fannie Mae/Freddie Mac), and SBA loans use a declining prepayment schedule instead:

• 5-4-3-2-1 step-down: 5% of balance in year 1, 4% in year 2, declining to 1% in year 5, then 0%.
• 3-2-1 step-down: 3% / 2% / 1% over three years.
• Flat percentage: e.g., 1% for the first 3 years, then open.

These are predictable and bounded. If you are 3 years into a 5-4-3-2-1 loan, the penalty is simply 2% of the balance — no rate-spread math. This makes refinance planning far easier, which is why many repeat borrowers prefer bank or agency debt over CMBS when they expect to sell or refinance within 5–7 years.

What Lenders Want to See and How Underwriters Use This

When you apply for a refinance, the new lender’s underwriter will:

1. Pull the payoff statement from your current servicer, which itemizes principal, accrued interest, and the prepayment penalty (yield maintenance or defeasance estimate).
2. Add the penalty to your loan amount for LTV purposes — a $90,000 penalty effectively raises your loan balance, tightening your loan-to-value and debt yield ratios.
3. Stress the break-even. The underwriter checks whether the interest savings on the new loan exceed the penalty within a reasonable window (often 24–36 months). If not, they may decline the refi or require more equity.

This is why your DSCR calculator and commercial mortgage calculator numbers matter before you ever request a payoff quote: you want to know your post-refi debt service before discovering the penalty makes the deal unworkable.

Acceptable prepayment exposure varies by lender and property type:

Lender type	Typical structure	When it bites
Bank portfolio	1–3% step-down, 1–5 yrs	Minor — predictable
Agency (Fannie/Freddie)	Declining, lockout year 1	Moderate in years 1–3
Life company	Yield maintenance or defeasance	High if rates fall
CMBS / conduit	Defeasance or yield maintenance + lockout	Highest — plan around it
SBA 7(a)	5%/3%/1% (3 yrs on the guaranteed portion)	Low to moderate

Strategies to Reduce or Avoid the Prepayment Penalty

• Time the payoff to an open period. Most loans have a window (often the last 3–6 months, or after the step-down hits zero) where prepayment is free. Check your note’s “open period” dates.
• Negotiate the structure upfront. If you anticipate selling or refinancing within 5 years, ask for a step-down or shorter yield-maintenance window at origination — lenders will often trade a slightly higher rate for friendlier prepayment terms.
• Use defeasance instead of yield maintenance when rates have risen; in a high-rate environment the defeasance bond basket can cost less than the make-whole, because the spread you owe on is negative or tiny.
• Model the break-even before acting. Compare the penalty plus refi costs against projected interest savings. Our commercial mortgage calculator handles the amortization side.
• Consider a bridge or supplemental loan instead of a full refi if only part of the penalty window remains — sometimes a second-position or mezzanine structure lets you wait out the open period.
• Refinance with the same lender/servicer. Occasionally a servicer will waive or reduce a penalty to keep the relationship, especially on bank portfolio loans. Ask — it costs nothing.

Prepayment and Yield Maintenance Calculator

Run your exact numbers through our dedicated yield maintenance calculator. It computes the make-whole penalty, compares it against a 3-2-1 step-down alternative, and shows your net benefit from refinancing after the penalty. For the broader amortization and payment impact, use the commercial mortgage calculator.

Frequently Asked Questions

Is a yield maintenance penalty tax-deductible? Generally, a prepayment penalty is treated as a cost of financing and may be deductible or amortized depending on whether the property is held for business/investment and how your accountant classifies it. Confirm with a CPA — this is not tax advice.

Can I prepay a portion of my loan to reduce the balance? It depends on the note. Yield-maintenance loans usually prohibit partial prepayment during the protected window (or apply the same make-whole formula pro-rata). Step-down loans often allow partial prepayments up to a capped percentage (commonly 20%) per year without penalty.

What’s the difference between a lockout period and yield maintenance? A lockout is a hard prohibition — you simply cannot prepay during that window. Yield maintenance lets you prepay but charges a make-whole fee. Many CMBS loans combine both: a 2-year lockout followed by yield maintenance to maturity.

Does refinancing always trigger the prepayment penalty? Only if you pay off the existing loan. If you refinance with the same lender and the lender treats it as a modification rather than a payoff, the penalty may not apply. This is lender-specific and worth negotiating.

How can RefiLoop help? RefiLoop connects you to 7,000+ lenders. We pre-screen your deal — including your current prepayment exposure — and match you to lenders whose structures fit your refinance timeline, so you are not blindsided by a penalty that erases your savings.