Defeasance is how many fixed-rate and CMBS loans are paid off early — by replacing the property as collateral with a portfolio of securities. Here's how it works and why it matters before you refinance or sell.
Defeasance is a prepayment method built into many CMBS and some fixed-rate commercial loans. Instead of paying off the balance, the borrower substitutes a portfolio of government securities that produces the same remaining payments the loan would have. The securities become the lender's collateral and the property is released.
You buy a basket of Treasuries or agency securities timed to replicate every remaining principal and interest payment through the loan's maturity or open window. A defeasance consultant assembles the portfolio, legal documents transfer it to a successor borrower, and your property is freed — typically so you can sell or refinance it clean.
When market rates are below your loan's rate, the securities needed to replicate your payments cost more than your outstanding balance — sometimes far more. That premium, plus transaction and legal fees, comes straight out of your refinance or sale proceeds, so it's essential to get a defeasance estimate before assuming a deal pencils.
Both compensate the lender for early payoff, but differently: yield maintenance is a cash penalty you pay directly, while defeasance requires buying and substituting securities. Yield maintenance is simpler; defeasance can be cheaper in some rate environments and is the standard for securitized (CMBS) loans.