Yield maintenance is a common clause in commercial real estate and large business loans that discourages borrowers from refinancing or paying off their loans early when interest rates fall. It guarantees the lender receives the same overall return as originally agreed by calculating the difference between the loan’s interest rate and current market rates, often benchmarked against U.S. Treasury yields with comparable maturity.
For example, if a borrower has a 10-year loan at 6% and prepays when current market rates are 4%, the lender loses expected interest income. Yield maintenance requires the borrower to pay a penalty covering this loss, effectively shifting interest rate risk from the lender to the borrower.
This penalty can be substantial, especially when rates have dropped significantly, impacting refinancing decisions. Yield maintenance clauses are primarily found in commercial real estate (CRE) loans, commercial mortgage-backed securities (CMBS) loans, and loans from institutional lenders like insurance companies and pension funds, as they typically seek predictable long-term returns.
Compared to other prepayment penalties, yield maintenance is among the most stringent. It differs from step-down penalties — which decline predictably over time — and defeasance, where borrowers replace loan collateral with government securities replicating the cash flow.
Borrowers negotiating commercial loans should carefully review prepayment terms. Understanding the formula, negotiating favorable conditions, and calculating potential penalties are critical steps. For more details on general prepayment penalties, see our glossary article on Prepayment Penalty.
For a thorough understanding of yield maintenance, borrowers should factor in these penalties when considering refinancing or early payoff to avoid unexpected costs. Reliable sources such as the Consumer Financial Protection Bureau provide insights into prepayment penalties’ protections and limits for consumers.
