Knowledge Base

Commercial Financing and Prepayment Penalties on Commercial Mortgage Loans

If You Try to Pay Off a Commercial Mortgage Loan Your Penalty Might Be 20% of the Balance!

Most commercial mortgage lenders making fixed rate commercial mortgage loans charge a prepayment penalty. The reason why is because the investors who buy commercial mortgage backed securities (CMBS) want a certain yield that is locked in. Why? Imagine you are a pension plan making actuarial projections to be sure you have enough money to pay your retirees. You need to know that you will earn a certain amount of interest. This is why you buy commercial mortgage backed securities.

The most common form of prepayment penalty is a defeasance formula. The legal definition of defeasance is, "A provision in an instrument that nullifies it if certain acts are performed."

When a borrower wants to pay off a fixed rate commercial mortgage loan, he must perform an act; i.e., he must give to the lender a bundle of U.S. Treasuries that provides the lender with the same stream of interest payments and the same balloon payment as the original mortgage.

Buying and assembling these U.S. Treasuries is immensely expensive, often on the order of 15% to 20% - and sometimes 25% - of the principal balance on the loan! Watch out for loans with a defeasance prepayment penalty.

You can find hundreds of fixed rate commercial lenders, many of whom have either small prepayment penalties or none at all, by using C-Loans.com: C-Loans Commercial Mortgage Lender Databank.

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