Commercial real estate prepayment penalty structures

Every fixed-rate commercial real estate loan says something about what happens if you repay it early, and the answer is rarely "nothing." The structure chosen at closing sets whether a mid-term refinance or a sale is practical, and by the time a buyer is at the table the term is no longer negotiable.

Three structures cover most of the market.

Step-down

The plainest of the three. Slatt Capital's explainer describes it as "the simplest and most borrower friendly," noting that "instead of calculating formulas or replacing collateral, a step-down is expressed as percentages tied to the outstanding balance." Their illustrative schedule runs "5%, 4%, 3%, 2%, 1%," declining by year.

The virtue is legibility. You can read next year's exit cost off the schedule without a model or a consultant, which makes step-down debt the easiest to plan a sale around.

Yield maintenance

Yield maintenance sizes a cash payment so the lender ends up where it expected to be. Slatt Capital describes the calculation as based on "the remaining loan balance, the present value of the remaining payments, and the difference between your loan rate and the yield on a similar Treasury." Commercial Real Estate Loans puts the purpose the same way: it "ensures a lender receives the same yield on a loan paid off early," charging a fee when the mortgage is paid off.

The consequence is that the penalty moves with rates and not with your intentions. The same page observes that yield maintenance "becomes more expensive when interest rates are falling and refinancing occurs at lower rates," which is the moment a borrower most wants to refinance. Falling rates make the exit attractive and expensive at the same time.

Defeasance

Defeasance is structurally different from the other two, because the loan is not repaid. Commercial Real Estate Loans describes it as a process that "replaces the collateral of a loan with securities which provide the lender with an equivalent return." Slatt Capital says the same thing from the borrower's side: "instead of paying off the loan, you replace the real estate collateral with government securities, usually Treasuries, that generate the same cash flow as the remaining loan payments."

It is the most operationally demanding option. Commercial Real Estate Loans notes the process "is generally so complex that a team of experienced accountants and legal experts are required to execute everything successfully," on top of "intensive capital investment into the replacement collateral," and Slatt Capital describes "assembling the securities, setting up a trust, and typically working with a defeasance consultant and attorneys." Defeasance is common in CMBS debt, where it is often the only permitted route out.

Why this is a record, not a research task

The cost of every one of these structures depends on the remaining term and, for two of them, on where Treasury yields sit on the day you exit. That makes the structure a standing input to portfolio decisions rather than something to look up when an offer lands.

TractTerm, part of Composed Studio, records prepayment penalty structures, yield maintenance, defeasance, step-down, or flat, as loan data alongside the maturity date, rate structure, and covenant register. It does not compute a payoff quote or price a defeasance. The servicer and the defeasance consultant do that, from the loan documents. What TractTerm gives you is the ability to answer "which of these loans can we exit cheaply" without opening twelve credit agreements.

The prepayment term also reframes the dates around it. An expensive exit makes the extension option more valuable and its notice deadline more consequential, and it changes how early a maturity has to be worked, since refinancing ahead of schedule may simply not be affordable. On floating-rate debt the calculus differs again, because the rate structure rather than a lockout drives the timing.