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Prepaying Loans: What your Lender Doesn’t Want You to Know
January 21, 2015
When negotiating your next loan, optimize your ability to prepay quickly with the least possible penalty and procedure. We asked Ackman-Ziff managing director Marc Warren to compare the two most common early-exit strategies: Yield maintenance and defeasance.
Securitized lenders like defeasance. A defeasance clause in your loan doc means buying treasuries in the bond market on behalf of your lender to prepay your loan. This process involves legal counsel, accounting opinions and title insurance, and could get expensive, complicated and time-consuming. Bankers could charge extra fees; bondholders find this process cleaner and easy to understand. Bonds backed by defeased loans make slightly higher profit for their originators than alternative forms of prepayment protection.
Yield maintenance is borrower-friendly. A more streamlined process than defeasance, yield maintenance is a payment of one lump sum based on the present value of all future payments— the math is the same but the timing and excess fees figure in when using defeasance.
Marc says the processes for both are actually similar, except that with defeasance, you buy a laddered set of bonds to simulate the outstanding payments due. Yield maintenance, on the other hand, only requires writing a simple check.
He adds that if you do take the defeasance route, there are quality advisers to help you navigate the process (he recommends Commercial Defeasance LLC, for one). As bonds backed by defeased loans are most desired by lenders, borrowers’ interest rates are lowest for these transactions. This can be attractive when (a typically large) owner has a large enough portfolio and is comfortable refinancing or selling the asset in the “open period” at the end of the loan (typically three to six months – the lender/bondholder will “pay up” for the shortest possible window while the borrower seeks the longest).
For more information from our education partner, Ackman-Ziff, click here.
