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Yield Maintenance for Residential Real Estate Investors

Yield Maintenance For Residential Real Estate Investors

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 term. A little lost, you search “yield maintenance” on Google and found this article which aims to help residential real estate investors like yourself better understand the term.

In general, yield maintenance is a type of prepayment penalty where the lender is guaranteed to fully receive scheduled interest payments until maturity. This is very common in commercial real estate and it protects the lender from any loss of unpaid interest resulted by prepayment of a loan. The idea is similar to a car lease. When you break your car lease, 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. 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 I Calculate My Yield Maintenance?
As an investor, it is important for you to understand how yield maintenance is calculated so that you can analyze how it would impact your investment goals.

The yield maintenance prepayment amount is not an easy calculation. Technically, no lender can tell you exactly how much you would owe in the future as the rates are constantly fluctuating.

But let’s hypothesize a situation. Assume these are the parameters of you loan: a 10-year, interest-only, $1M mortgage at 6%. After year 7 (10-7 = 3 more years to go), you decide to refinance (or sell). The yield maintenance prepayment penalty would equal the total of your interest payments 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 amount per year for the remaining 3 years on your loan.

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The rationale for this is so the lender can re-invest a borrower’s principal balance into the matching treasury to recover the 1% interest. By exiting early, the borrower will be responsible for paying the lender for its remaining lost income from interest.

Although there are many different yield maintnenance calculators that you can find through a quick online search, make sure that you note each calculation is based upon your specific terms. Here is an example of a good calculator.

What Does Yield Maintenance Mean to an Investor?

Yield Maintenance can sound quite intimidating at first, but whether or not yield maintenance makes sense to you depends on your 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 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 yield maintenance would only apply. For example, if you have 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. 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 in year 8, 9, or 10, then yield maintenance should not scare you away.

More questions on yield maintenance? CoreVest is a leading provider of financing solutions to residential real estate investors. We provide attractive long-term 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 business, please call 844.223.2231 or submit our contact form.

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