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

[@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

[@vinceliu605]

So with defeasance, you would use the proceeds that would have been used to pay off the loan to purchase treasury securities instead? And the proceeds can come from another loan/institution (refinance) or a buyer (sale)?

[@RealEstateFinanceAcademy]

Check the loan terms. The borrower must reimburse the lender for the lost interest that isn’t covered by the lender’s reinvestment. The lender defines the calculation in the loan documents. To estimate, check out www.defeasewithease.com Hope that helps. - 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