Defeasance

Defeasance is a prepayment method, common on CMBS loans, where the borrower replaces the property as loan collateral with a portfolio of government securities that replicate the loan's remaining payment stream. Rather than actually paying off the loan early, the borrower purchases and pledges bonds sufficient to make all future payments, releasing the real estate lien while the loan itself technically stays outstanding.

Defeasance exists because CMBS loans are pooled and sold to bond investors who expect a predictable, fixed income stream; if borrowers could simply prepay whenever they wanted, that would disrupt the cash flows promised to bondholders. Defeasance solves this by keeping the loan's payment stream intact — just backed by bonds instead of real estate — so bondholders keep receiving exactly what they expected.

The process is complex and expensive: it requires hiring a defeasance consultant, legal counsel, and often a rating agency confirmation, and the cost of the replacement securities is driven by prevailing Treasury or agency bond yields relative to the loan's interest rate. When rates have fallen since origination, defeasance can be dramatically more expensive than the loan's remaining balance, because more bond principal is needed to replicate the same payment stream at lower prevailing yields.

Defeasance is functionally an alternative to yield maintenance, and the two are rarely both present on the same loan — CMBS conduit loans typically use defeasance, while balance-sheet, agency, or life-company loans more often use yield maintenance instead.

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