By Fred Matera, CIO, Redwood Trust A lack of affordability will lead to near-term weakness,…
You’re looking for a real estate investment loan and the lender mentions that the loan is subject to Yield Maintenance Prepay. You nod your head, but it’s is the first time you’ve ever heard of this mortgage loan term. This article which aims to help residential real estate investors like yourself better understand loans and mitigating fees from lenders.
In this article we’ll cover these topics related to Yield Maintenance:
- How do you Calculate Yield Maintenance Prepayment Penalty
- Yield Maintenance Calculator
- What is the Difference Between Yield Maintenance and Defeasance
- What Does Yield Maintenance Mean to a Real Estate Investor
In general, yield maintenance is a type of prepayment penalty where the mortgage lender is guaranteed to fully receive scheduled payment of interest rates until maturity. This is very common in commercial real estate and it protects the lender from any loss of unpaid interest rate resulted by prepayment of a loan. The idea is similar to a car lease. When a borrower breaks a car lease loan, you are typically required to pay all of the remaining monthly payments as a penalty.
For many residential investors, this type of penalty may sound harsh and effect your loan payments. But, if they better understand why yield maintenance is needed from a lender perspective, it will make a lot of sense for investors as well.
How do you Calculate Yield Maintenance Prepayment Penalty
As a borrower, it is important for you to understand how yield maintenance is calculated so that you can analyze how the rate would impact your investment goals, present value of your investment and prepayment fee ( if any ).
The yield maintenance prepayment amount is not an easy calculation. Technically, no real estate lender can tell the borrower exactly how much they would owe in the future as the rates are constantly fluctuating.
But let’s hypothesize a situation. Assume these are the parameters of you real estate loan: a 10-year date, interest-only, $1M mortgage at 6%. After the year 7 date (10-7 = 3 more years to go), you decide to refinance for a lower interest rate (or sell). The yield maintenance prepayment penalty would equal the total of the borrowers interest rates payment for 3 years, with the yield calculated as the difference between the coupon rate of 6% and the matching Treasury of the remaining term until maturity (3 Year Treasury). Let’s assume that 3-year Treasury rate is at 1%. That means you would owe 5% (6%-1%) of the interest rate amount per year for the remaining 3 years on your loan.
The rationale for this is so the lender can re-invest the borrowers principal rate balance into the matching treasury to recover the 1% interest from the mortgage. By exiting early, the borrower will be responsible for paying the lender for its remaining lost income from interest.
Yield Maintenance Calculator
Although there are many different yield maintenance calculators that you can find through a quick online search, make sure that you note each calculation is based upon your specific terms.
What is the Difference Between Yield Maintenance and Defeasance
With defeasance, this provides a great benefit in the payments structure to the borrower. There is no 1% minim fee, where as the yield maintenance has this. With defeasance, you do have to go through more lender requirements in order to qualify.
What Does Yield Maintenance Mean to a Real Estate Investor
Yield Maintenance can sound quite intimidating at first, but whether or not it makes sense to borrowers depends on your real estate payment strategy and exit plan. If you are looking to sell your asset or refinance your property within the earlier periods of the loan term, then it may not make sense to take a loan with a yield maintenance prepayment penalty unless your returns make up for the cost of early exit. However, if your plan is to hold the asset and continue with fixed debt financing until maturity date, the yield maintenance prepayment would not affect you at all.
Keep in mind that the yield maintenance period is the timeframe in which it would only apply. For example, if the borrower has a 10-year loan with a yield maintenance prepayment period of 7 years, that means you are off the hook from a potential prepayment penalty after 7 years with your debt. If you know for a fact that you will not be prepaying for the first 7 years and plan to potentially sell off the asset for present value in year 8, 9, or 10, then the yield should not scare you away.
CoreVest is a leading provider of financing solutions to residential real estate investors. We provide attractive long-term commercial debt products for stabilized rental portfolios as well as credit lines for new acquisitions. For more information about how CoreVest can help grow your rental and rehab real estate business, please call 844.223.2231 or submit our contact form.