The short version
Yield maintenance is a contractual cash premium calculated from the present value of lost loan interest. Defeasance replaces the real estate collateral with a portfolio of government securities designed to make the remaining debt payments. Neither is automatically cheaper; the answer depends on the note rate, remaining term, Treasury curve, loan documents, and transaction expenses.
Yield maintenance
The borrower pays the outstanding principal plus a premium intended to compensate the lender for reinvesting prepaid funds at a lower rate. The formula usually discounts the remaining scheduled debt service against a defined Treasury yield, sometimes with a floor.
Defeasance
The loan stays outstanding, but the property is released from its lien after a successor borrower assumes the debt and a securities portfolio is pledged to fund every remaining payment through maturity or an open prepayment date.
Key mechanical differences
| Factor | Yield maintenance | Defeasance |
|---|---|---|
| Loan outcome | Loan is prepaid | Loan remains outstanding |
| Primary cost | Contractual premium | Securities shortfall plus transaction costs |
| Execution | Typically simpler | Specialists, legal work, custody, and accounting |
| Rate sensitivity | Discount-rate formula | Cost of matching securities |
When might a borrower prefer each?
A borrower may prefer yield maintenance when the documents permit it and speed and simplicity matter. Defeasance is often required by securitized loan documents and may be the only route to release the property before maturity. Compare the full economics, not just the headline premium: include legal, consultant, securities, successor-borrower, custody, and accounting fees, as well as the expected closing timeline.
How market rates affect the result
Falling Treasury yields generally increase both a yield-maintenance premium and the cost of a defeasance portfolio because replacing above-market loan cash flows becomes more expensive. Rising yields can reduce the economic penalty, although document-specific floors may prevent a yield-maintenance calculation from falling below a minimum amount.