| Detail | Explanation |
|---|---|
| Most common on | CMBS loans and some other securitized fixed-rate loans |
| What changes | Collateral switches from the property to a securities portfolio |
| What stays | The loan, its rate, and its payment schedule |
| Cost components | Securities cost above the balance plus third-party and servicer costs |
How does defeasance work step by step?
- The borrower gives the servicer notice within the window set by the loan documents
- A defeasance consultant sizes a portfolio of eligible securities that matches each remaining payment
- An accountant certifies that the portfolio cash flows cover the payments
- A successor borrower entity is formed to assume the loan
- At closing the borrower buys the securities, pledges them as collateral, and the mortgage is released
- The successor borrower makes the remaining payments from the securities until maturity or the open date
Worked example: pricing the securities portfolio
In this hypothetical example, a borrower defeases a $10,000,000 interest-only loan at 5.00% with 3 years left to its open date. The portfolio must produce $500,000 at the end of each year plus the $10,000,000 balance at year 3. If eligible securities yield 4.00%, the portfolio costs about $10,277,509 and exceeds the balance by $277,509 in total. If those securities yield 6.00%, the portfolio costs about $9,732,699 and comes in below the balance. Consultant, legal, accounting, successor borrower, and servicer costs come on top in both cases. Real portfolios match monthly payments and actual bond prices, so results differ.
| Securities yield | Portfolio cost | Cost versus balance |
|---|---|---|
| 4.00% | $10,277,509 | $277,509 above |
| 6.00% | $9,732,699 | $267,301 below |
Why do CMBS loans use defeasance?
A CMBS loan sits in a trust whose bondholders expect a predictable stream of payments. Paying the loan off early would disrupt that stream. Defeasance keeps the payments flowing on schedule while letting the borrower sell or refinance the property. Many CMBS loans also carry an early lockout, and defeasance is often not permitted until a set period after securitization.
How defeasance compares with yield maintenance
Both approaches protect the lender's expected return, and both get cheaper as Treasury yields rise. Yield maintenance is a cash premium on a payoff, while defeasance is a collateral substitution that takes more parties and more time. The yield maintenance vs defeasance guide covers the tradeoffs in full.
Planning a defeasance
Defeasance involves a consultant, securities intermediary, accountants, the servicer, and counsel on both sides, so sponsors typically start well ahead of a sale or refinance closing. Loan documents govern which securities qualify, the notice period, and whether the borrower keeps any excess value, and those terms vary by loan. Borrowers can check current Treasury yields, published daily by the U.S. Treasury, to gauge direction before ordering a quote, then compare new loan payments in the commercial mortgage calculator. Capital Partners models prepayment costs when arranging a commercial refinance, and you can submit a deal to compare the payoff path against new debt proceeds.
Sources
Common questions
How much does it cost to defease a loan?
The cost is the securities portfolio price minus the loan balance, plus third-party and servicer costs. It is highest when Treasury yields are well below the loan rate and when many years remain.
Can defeasance ever make money?
When Treasury yields are above the loan rate, the portfolio can cost less than the balance. Whether the borrower captures that difference depends on the loan documents and how the successor borrower is structured.
What is a successor borrower in defeasance?
It is a new single-purpose entity that assumes the defeased loan and holds the securities. It is often provided by a defeasance services firm so the original borrower is released.
Can I defease a loan any time?
No. Most CMBS loans prohibit defeasance during an initial lockout period, and the documents set notice requirements and eligible dates.
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