A defeasance fee is what a commercial borrower pays to release a property from a loan that doesn’t permit straight prepayment. The money doesn’t retire the debt. It buys a portfolio of U.S. Treasury securities that will produce the exact same principal and interest payments your loan still owes, on the same dates, through maturity. The single biggest factor in how much that portfolio costs is the gap between your loan’s interest rate and current Treasury yields: when Treasuries yield less than your loan rate, the fee climbs above your outstanding balance, and when they yield more, the fee can actually come in below it.
What the Fee Actually Pays For
Defeasance swaps out the collateral behind a loan rather than paying the loan off. Your real estate is replaced by government securities, the mortgage lien is released, and the loan itself continues to exist on paper until its scheduled maturity date. A newly formed successor borrower assumes the loan and holds the Treasury portfolio for the remaining term. From the bondholders’ perspective, nothing has changed. They still receive the same payments on the same dates.
This structure exists because most commercial mortgage-backed securities (CMBS) loans sit inside trusts governed by a Pooling and Servicing Agreement, which is written to protect the cash flow bondholders were promised. Paying the loan off early would break that cash flow, so the agreement requires a substitute income stream instead. Treasuries are used because they carry essentially no credit risk, which makes them at least equal to the original real estate in the eyes of the trust.
How the Fee Is Calculated
The core of the fee is the market price of the Treasury securities needed to match every remaining payment on your loan schedule. It works like a custom bond ladder: each rung corresponds to a payment date, and each rung has to throw off exactly the right dollar amount of principal and interest on that date. A defeasance consultant runs the math against the Treasury yield curve and selects a mix of bills, notes, and bonds whose maturities and coupons line up with the loan’s remaining payments.
The variable that moves the price the most is the spread between your loan’s coupon and current Treasury yields. If your loan carries a 6% rate and comparable Treasuries yield 4%, each dollar of Treasuries generates less income than each dollar of your loan, so you have to buy more face value to produce the required cash flow. That extra face value is the premium you pay. The wider the spread, the more expensive the defeasance.
When the Fee Comes in Below Your Loan Balance
The fee doesn’t always exceed the outstanding principal. When Treasury yields sit above your loan’s rate, you can buy the required securities for less than the loan balance. This is called negative defeasance, and it means you finish the transaction having spent less than what you owed. Borrowers with older loans originated during low-rate periods have periodically found themselves in this position when rates rise.
A Simplified Example
Say you have a $10 million loan at 5.5% with three years of payments left. If three-year Treasuries yield 3.5%, the portfolio needed to replicate your payment stream might cost roughly $10.6 million, putting the premium around $600,000 on top of the outstanding balance. Flip the yields so Treasuries pay 6.5%, and that same portfolio might run about $9.7 million, roughly $300,000 less than the balance. The exact figures depend on the specific payment schedule and the shape of the yield curve, but the direction is consistent: falling rates make defeasance expensive, rising rates make it cheap.
Transaction Costs Beyond the Securities
The Treasury portfolio is the largest expense, but not the only one. Defeasance is a coordinated legal and financial process with multiple professional parties, each of whom charges fees:
- A defeasance consultant structures the portfolio, coordinates the closing, and typically arranges the successor borrower.
- Separate attorneys usually represent the borrower, the loan servicer, and the trust.
- An independent CPA firm issues a verification letter confirming that the Treasury portfolio will cover every remaining payment.
- The successor borrower entity has to be formed, documented, and maintained through the rest of the loan term.
Industry participants commonly cite a range of $50,000 to $200,000 for these combined professional costs, depending on loan complexity, the number of properties, and whether the timeline is standard or rushed. Giving the servicer less than 30 days’ notice often triggers additional rush fees.
When You’re Allowed to Defease
CMBS loans don’t allow defeasance at any point in the term. The typical prepayment structure has three phases, and which one you’re in decides both your options and your cost.
- Lockout period. For the first two to five years of most conduit CMBS loans, no prepayment or defeasance is permitted. Federal tax rules add a separate floor: loans held by a Real Estate Mortgage Investment Conduit (REMIC) can’t be defeased within two years of the trust’s startup day. Whichever restriction is longer controls.1eCFR. 26 CFR 1.860G-2 – Other Rules
- Defeasance window. After the lockout expires, borrowers can defease (or in some loans pay a yield maintenance fee) for most of the remaining term. This is where the calculation above matters most.
- Open period. Most CMBS loans include a stretch of roughly three to four months before maturity when the borrower can simply pay off the outstanding balance plus accrued interest, with no defeasance or prepayment penalty at all.
If your sale or refinance can be timed into the open period, you avoid the defeasance fee entirely. Landing there can save hundreds of thousands of dollars, though it requires closing certainty that real estate transactions don’t always offer.
How Defeasance Compares to Other Prepayment Costs
Not every commercial loan uses defeasance. The prepayment clause in your loan documents controls which mechanism applies, and borrowers rarely get to switch mechanisms after origination.
Yield Maintenance
Yield maintenance is a lump-sum cash payment calculated to compensate the lender for lost future interest, based on the present value of the difference between your loan rate and a reference Treasury rate over the remaining term. Unlike defeasance, it actually retires the debt. No successor borrower, no Treasury portfolio, no collateral administrator. Transaction costs are lower and closings are faster. The trade-off is that in a falling-rate environment the lump sum can be very large, and you have to bring that cash to closing rather than substituting collateral.
Standard Prepayment Penalties
Some portfolio loans held by a single lender use a fixed-percentage penalty that declines over the term, such as 5% of the outstanding balance in year one, stepping down one point each year. The cost is predictable from the day you close. These penalties are uncommon in CMBS loans because a securitized structure needs a cash-flow replacement, not a simple penalty payment.
Which Costs More
The answer turns almost entirely on interest rates. In a falling-rate environment, both defeasance and yield maintenance get expensive because you’re compensating the lender for a rate advantage they’d otherwise keep. Defeasance carries higher transaction overhead, but the securities purchase and the yield maintenance lump sum are driven by the same rate differential. In a rising-rate environment, defeasance can produce a negative premium, while yield maintenance formulas in some loan documents include floors that stop the penalty from dropping to zero. The only reliable way to know which will treat you better at exit is to read the specific prepayment clause in your loan documents.
Negotiating the Fee Down Before You Sign
The moment to influence your defeasance costs is at origination, not when you’re trying to sell the property. Several provisions in the loan documents shape what you’ll eventually pay.
Lockout length matters. A two-year lockout gives you far more flexibility than a five-year lockout, especially if your business plan involves repositioning and selling within a few years. The definition of permitted securities matters too. Some loan documents allow U.S. agency securities, such as those issued by Fannie Mae or Freddie Mac, as defeasance collateral in addition to Treasuries.2Fannie Mae. Defeasance – Fannie Mae Multifamily Guide Agency securities sometimes yield slightly more than Treasuries, which can trim the portfolio cost.
The notice period, the length of the open prepayment window, and your right to select your own defeasance consultant are all negotiable at origination. Experienced borrowers also negotiate caps on servicer legal fees and pre-approve the successor borrower structure to avoid disputes at closing. None of these terms can be changed once the loan is securitized, so origination is effectively your only chance to shape the economics of a future defeasance.