Defeasance
A method of paying off a commercial or securitized loan early by substituting the property with a portfolio of government securities that replicates the loan's remaining payments, rather than paying cash to the lender.
Defeasance is a prepayment mechanism used mostly on securitized commercial real estate loans (CMBS) and some large portfolio rental loans. Instead of handing the lender a cash payoff, the borrower replaces the property as collateral with a portfolio of U.S. government securities structured to throw off exactly the cash flows the loan was scheduled to receive — every remaining monthly payment plus the balloon.
The reason it works this way is bond-market plumbing: when a loan is securitized, investors bought bonds backed by that specific stream of payments. The loan documents won't allow a simple cash prepayment because it would disrupt the bond. Defeasance keeps the payment stream intact (now funded by Treasuries) while freeing the real estate so the investor can sell or refinance it.
How it works
- The borrower notifies the servicer of intent to defease.
- A defeasance consultant calculates the Treasury portfolio needed to cover all remaining payments.
- The borrower buys those securities and pledges them as substitute collateral.
- The property lien is released; the loan continues on paper, paid by the securities.
- A successor borrower entity typically takes over the defeased note.
A worked example
An investor has a $3,000,000 CMBS loan with 4 years left at 5.5%. To defease, they must buy a Treasury portfolio that produces every remaining payment and the balloon. If Treasury yields are below the 5.5% note rate, that portfolio costs more than the loan balance — say $3.25M — and the ~$250k premium plus transaction costs ($50k–$100k in legal, accounting, and consultant fees) is the real cost of exiting early.
How it's used in investor lending
Defeasance is the securitized-loan cousin of yield maintenance. Most small investor DSCR loans and hard money loans use a simple prepayment penalty instead — defeasance only appears on larger, conduit-style debt. The key planning point: defeasance is expensive and time-consuming (30–45 days, multiple advisors), so investors holding securitized debt must factor it into any sale or refinance takeout timeline. Like yield maintenance, the cost falls as rates rise toward the note rate.
This is general information, not legal, tax, or financial advice.
Frequently asked questions
What's the difference between defeasance and yield maintenance?
Both compensate the lender for an early payoff, but the mechanics differ. Yield maintenance is a cash penalty paid directly to the lender. Defeasance substitutes the real estate collateral with a portfolio of government securities that keeps paying the loan; the property is then released. Defeasance is standard on securitized (CMBS) loans, while yield maintenance is common on portfolio and bank loans.
How much does defeasance cost?
Two parts: the cost of the Treasury portfolio (which can exceed the loan balance when rates are below your note rate) plus transaction costs of roughly $50,000 to $100,000+ for legal, accounting, rating-agency, and consultant fees. The total shrinks as market rates rise toward your note rate.
Do small DSCR or hard money loans require defeasance?
Almost never. Defeasance is reserved for large securitized commercial loans. Small-balance investor loans use simpler prepayment penalties like step-downs or yield maintenance, which are far cheaper and faster to satisfy.