Defeasance

Defeasance of a securitized commercial mortgage is a process in commercial real estate finance by which a borrower substitutes other income-producing collateral for a piece of real property to facilitate the removal (defeat) of an existing lien (entailment of the property) without paying-off (through a transfer of liquid assets) of the existing note. Generally, a basket of United States treasury obligations is the only collateral “acceptable” for this type of substitution – although some securitized loan documents do allow for the use of agency securities that are less costly. A quick way to get an estimate of the cost of a defeasance is to use a defeasance cost calculator.The original note remains in place after a defeasance, but it is collateralized and serviced by the substituted securities instead of the real estate. These securities can be held by either the original borrower or by a “successor borrower” entity which uses the income from/disposition of the securities to make the monthly debt service payments and balloon payment on the mortgage being defeased. The premium a borrower pays to defease (what some refer to incorrectly as a “penalty”) is the total cost of purchasing the securities less the outstanding balance on the loan. Payments to Commercial mortgage-backed security bondholders are not disrupted, and the borrower can sell or place a new first lien on the property. Unlike yield maintenance, defeasance is neither a type of prepayment nor a prepayment penalty.