Prepayment Penalties - Step Down, Yield Maintenance, and Defeasance Explained

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Understanding Prepayment Penalties on Commercial Loans: A Detailed Guide
In this highly informative video, Trevor shares crucial insights into the three types of prepayment penalties - Step-down Prepayment Penalty, Yield Maintenance, and Defeasance - found in commercial loans. He provides detailed examples and calculations, showcasing how each type of prepayment penalty could impact borrowers if they decide to pay their commercial loans ahead of schedule, which can either be beneficial or extremely expensive. This video is essential viewing for any commercial loan borrower looking to navigate their way around prepayment penalties and mitigate risks that could have significant financial impacts.
0:00 Prepayment Penalties, Yield Maintenance, and Defeasance
00:42 Step-Down Prepayment Penalty
01:18 Yield-Maintenance
02:29 Defeasance
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[@familialfsme7153]

Thank you Professor , Top professor who explains everything and gets straight to the point.

[@smolentsevalexander]

Straight to the point, great visualization, well formulated explanation. Great video as always!

[@RealEstateFinanceAcademy]

Thank you, Alexander. I appreciate your comments. Thanks for watching! - Trevor

[@shrishtisunder4040]

Is 3-2-1 Step-Down prepayment penalty cumulative where 3% added on first year is then summed with another 2% in the second year for 5% or does the 3% only last duration of one year then get replaced by a different 2%? Does that 3% then added 2% then added 1% on mortgage all gain accrued interest or any interest over the prepayment paid years?

[@RealEstateFinanceAcademy]

Hi there. Thanks for your question. No, the step-down prepayment penalty is not cumulative. For example, if you have a $1 million balance left on your loan, the penalty will depend on when that is. So if it's in year 1 (with a 3% penalty), then the lender would add $30k to your payoff. If it was year 2 (with a 2% penalty) then it would be $20k, and in year 3 (with a 1% penalty) they would only add $10k to the payoff. Keep in mind, this is on top of any accrued interest that is owed. The reason for this is the lender anticipates making interest on the loan for several years, at least. If the borrower pays the loan off early, then the lender has to incur the expense to originate a new loan with those funds. Pre-payment is a privilege, not a right. So the pre-payment penalty compensates them for the early payoff.
Hope that helps! Let me know if you have more questions. - Trevor