Mortgage Prepayment by Defeasance

USC Law School, Olin Working Paper No. 99-13

7 Pages Posted: 16 Sep 1999

See all articles by George Lefcoe

George Lefcoe

University of Southern California Law School

Abstract

To protect against losses when borrowers prepay to take advantage of declining interest rates, banks and insurance companies have come to rely on "yield maintenance" clauses. These provisions require the borrower to make a lump sum payment to cover the lender?s potential loss from reinvesting prepaid sums. For reasons described later, yield maintenance provisions have proved woefully insufficient to compensate the holders of securitized commercial mortgage loans when borrowers prepay. Increasingly, mortgage loans originated for sale through commercial mortgage backed securities (CMBS) only allow prepayment through defeasance. Under defeasance provisions, prepaying borrowers must provide Treasury obligations exactly matching the cash flow of all scheduled mortgage payments. This article compares the practical consequences of yield maintenance to defeasance provisions for commercial borrowers and mortgage bond investors.

JEL Classification: G12

Suggested Citation

Lefcoe, George, Mortgage Prepayment by Defeasance. USC Law School, Olin Working Paper No. 99-13, Available at SSRN: https://ssrn.com/abstract=172987 or http://dx.doi.org/10.2139/ssrn.172987

George Lefcoe (Contact Author)

University of Southern California Law School ( email )

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