Loan defeasance is a financial strategy used in real estate financing. It involves setting up a trust account with government securities to make future loan payments. This allows borrowers to release properties from their loans, often for sale or refinancing, without paying off the loan in full. It’s a way to change property ownership or financing while preserving cash flow.
Loan Defeasance Calculator
Loan Defeasance Table Example
| Year | Remaining Loan Balance | Principal Payment | Interest Payment | Total Payment | Securities Income | Net Payment |
|---|---|---|---|---|---|---|
| Year 1 | $1,000,000 | $50,000 | $30,000 | $80,000 | $80,000 | $0 |
| Year 2 | $950,000 | $50,000 | $28,500 | $78,500 | $78,500 | $0 |
| Year 3 | $900,000 | $50,000 | $27,000 | $77,000 | $77,000 | $0 |
| … | … | … | … | … | … | … |
| Year 10 | $500,000 | $50,000 | $15,000 | $65,000 | $65,000 | $0 |
| Year 11 | $450,000 | $50,000 | $13,500 | $63,500 | $63,500 | $0 |
| Year 12 | $400,000 | $400,000 (Loan Paid Off) | $12,000 | $412,000 | $12,000 (Remaining Securities Income) | $400,000 (Remaining Loan Balance) |
In this simplified example:
- We have a $1,000,000 loan with annual payments of $80,000 (principal + interest).
- The borrower establishes a defeasance account with government securities that generate the same annual income as the loan payments.
- Each year, the borrower pays the loan using the income from the securities, and the remaining loan balance decreases.
- After 12 years, the loan is fully paid off, and the remaining securities income becomes the borrower’s.
FAQs
How is defeasance calculated? Defeasance is calculated by determining the present value of all future cash flows of the loan being defeased, including both the remaining principal and interest payments. This calculation is typically performed using a financial calculator or spreadsheet software.
How does a defeasance work? In a defeasance, a borrower sets up a portfolio of U.S. government securities or other highly-rated bonds in a defeasance account. The interest and principal payments from this portfolio are used to make the future loan payments. This allows the borrower to release the property from the original loan and transfer it to a new owner or refinance without the original lender’s involvement.
How do you calculate yield maintenance on a prepayment? Yield maintenance is calculated by determining the present value of the remaining loan payments, including both principal and interest, at the contracted interest rate. This calculation takes into account the time remaining until maturity, and any difference between the contracted interest rate and the current market interest rate.
What is a defeasance account? A defeasance account is a trust account established by the borrower to hold a portfolio of U.S. government securities or other highly-rated bonds. The income generated from this portfolio is used to make the remaining payments on a loan that is being defeased.
What is an example of defeasance? An example of defeasance is when a commercial real estate borrower decides to sell their property before the loan matures. To do so, they establish a defeasance account and purchase a portfolio of government securities with a value equal to the remaining loan payments. The income from this portfolio is used to continue making the loan payments, allowing the borrower to transfer the property to the new owner with the original loan no longer encumbering it.
What is the defeasance clause in a loan? The defeasance clause in a loan agreement outlines the terms and conditions under which a borrower can defease, or release, the property from the original loan. It specifies the requirements for establishing a defeasance account, the types of securities that can be used, and the process for transferring the property to a new owner.
What is the difference between defeasance and payoff? Defeasance involves setting up a portfolio of securities to continue making loan payments, while payoff is the act of repaying the loan in full with a lump-sum payment. Defeasance typically occurs when a borrower wants to transfer or refinance a property without paying off the original loan, whereas payoff involves clearing the debt entirely.
What does call defeased mean? “Call defeased” typically refers to callable bonds that have been defeased. Callable bonds are bonds that can be redeemed (called) by the issuer before their maturity date. When such bonds are defeased, it means that the issuer has set aside sufficient funds to retire the bonds at a future date, effectively removing them from circulation.
What is the difference between defeased and retired? Defeased typically refers to bonds or loans that have been secured with assets or securities set aside to meet future payment obligations. Retired, on the other hand, means that the bonds or loans have been paid off in full and are no longer outstanding.
What is the formula for loan yield? Loan yield can be calculated using the following simplified formula:
Loan Yield (%) = (Interest Received + Fees) / Principal Loan Amount
How do you calculate all in yield on a loan? All-in yield on a loan takes into account not only the interest received but also any fees and costs associated with the loan. The formula for all-in yield is:
All-In Yield (%) = (Interest Received – Costs and Fees) / Principal Loan Amount
How do you calculate all in yield on a term loan? To calculate the all-in yield on a term loan, use the same formula as above by considering the interest received, costs, and fees associated with the specific term loan in question.
What is a loan defeasance fee? A loan defeasance fee is a fee charged by a lender when a borrower chooses to defease (replace) a loan with a portfolio of securities rather than paying it off in full. This fee compensates the lender for the administrative costs and potential income loss associated with the defeasance process.
Why Defease debt? Debt defeasance is often done to release collateral, such as real estate, from the original loan. This allows borrowers to sell the property or refinance it without paying off the loan entirely. It can also be a way to reduce interest rate risk or to take advantage of lower market interest rates.
What is the defeasance date? The defeasance date is the date on which the defeasance process becomes effective. It is the point at which the borrower’s obligation to make future loan payments is replaced by the income generated from the securities held in the defeasance account.
Which form of financing would be the greatest risk to the buyer? The greatest risk to a buyer typically comes from higher-risk financing options, such as unsecured loans, loans with variable interest rates, or loans with balloon payments. These forms of financing can lead to higher costs and greater uncertainty for the buyer.
What is the difference between legal defeasance and in substance defeasance? Legal defeasance refers to the complete discharge of a debt obligation, while in substance defeasance means that the borrower has set aside funds or assets in a trust to meet future debt payments, but the debt remains on the books as a liability.
What is a CMBS loan? A CMBS (Commercial Mortgage-Backed Securities) loan is a type of commercial real estate loan that is bundled with other similar loans and sold to investors as securities. The income generated from the underlying mortgage loans is used to pay interest and principal to the investors who hold the CMBS securities.
What are discount points in a loan? Discount points are upfront fees paid by borrowers to lower their interest rate on a mortgage or loan. Each discount point typically costs 1% of the loan amount and can reduce the interest rate by a predetermined amount, often 0.25% per point.
What clauses should be in a loan agreement? Loan agreements typically include clauses covering the loan amount, interest rate, repayment terms, collateral, default conditions, covenants, fees, and dispute resolution mechanisms, among others.
What is the default clause in a loan agreement? A default clause in a loan agreement specifies the conditions under which the borrower is considered in default of the loan. It outlines the consequences of default, which may include acceleration of the loan, additional fees, and actions the lender can take to collect the debt.
Why is payoff more than principal? The payoff amount on a loan is often more than the principal because it includes not only the remaining principal balance but also accrued interest and any applicable fees or prepayment penalties.
Why is loan payoff higher than balance? The loan payoff is higher than the outstanding balance because it includes interest that has accrued since the last payment, as well as any applicable fees or charges.
Why is mortgage payoff more than principal? Mortgage payoff is typically more than the principal because it includes both the remaining principal balance and any interest that has accrued since the last payment.
What is the difference between call money and call loan? Call money and call loans both refer to short-term borrowing in the financial markets, but call money is typically used by banks to lend to other banks, while call loans are often extended by banks to securities brokers and dealers.
What is a synonym for the word defease? A synonym for “defease” could be “secure,” “guarantee,” or “encumber.”
What is calling back a loan? “Calling back a loan” typically refers to the lender exercising their right to demand early repayment of a loan, often due to specific conditions outlined in the loan agreement.
What does retiring debt do? Retiring debt means paying off a debt in full, resulting in the complete elimination of the debt obligation.
What does it mean when debt is retired? When debt is retired, it means that it has been fully paid off and is no longer outstanding.
What does it mean when a loan is retired? When a loan is retired, it means that it has been fully paid off and is no longer an active obligation.
What is a good debt yield? A good debt yield is typically considered to be at least 10-12%, but this can vary depending on factors such as the type of property, location, and risk profile.
How do banks calculate loan yield? Banks calculate loan yield by considering the interest received from the loan, any fees or charges associated with it, and the risk of default. The formula for loan yield is similar to the one mentioned earlier.
What is the yield of a lender on a loan? The yield of a lender on a loan refers to the return or profit that the lender earns from lending money to the borrower. It takes into account the interest income and any fees or costs associated with the loan.
How do I calculate loan yield in Excel? To calculate loan yield in Excel, you can use a formula like this:
Loan Yield (%) = (Interest Received + Fees) / Principal Loan Amount
You would replace “Interest Received” with the actual interest income and “Fees” with any fees associated with the loan.
What is an example of a yield calculation? An example of a yield calculation is calculating the yield on a bond. Suppose you have a bond with a face value of $1,000, an annual coupon payment of $60, and you purchased it for $950. The yield would be calculated as follows:
Yield (%) = (Annual Coupon Payment / Purchase Price) x 100 Yield (%) = ($60 / $950) x 100 Yield (%) = 6.32%
What is the formula for yield on loans and advances? The formula for yield on loans and advances is similar to the one mentioned earlier for loan yield:
Yield (%) = (Interest Received + Fees) / Principal Loan Amount
What is the percentage of yield? The percentage of yield represents the rate of return on an investment, typically expressed as a percentage. It indicates how much income or profit an investment generates relative to its initial cost or principal.
What is the penalty for paying off a loan early? The penalty for paying off a loan early, if applicable, can vary depending on the terms of the loan agreement. It may include prepayment penalties, which are fees charged to borrowers for paying off a loan before its scheduled maturity date.
What is a loan that can be paid off early? A loan that can be paid off early is a loan that allows borrowers to make additional payments or repay the entire outstanding balance before the scheduled maturity date without incurring significant prepayment penalties.
What is the upfront fee for a loan? The upfront fee for a loan is a fee that borrowers may be required to pay at the time the loan is originated or as part of the closing costs. It can include application fees, origination fees, or other charges associated with obtaining the loan.
Why does debt yield matter? Debt yield matters because it helps lenders assess the risk associated with a loan. A higher debt yield indicates a lower risk for the lender, while a lower debt yield may suggest higher risk.
Why do people sell debt? People sell debt, such as bonds or loans, for various reasons, including raising capital for investments, managing cash flow, transferring risk to investors, and diversifying their financial portfolio.
Why is debt financing better? Debt financing can be advantageous because it allows businesses and individuals to access capital without giving up ownership or equity in their assets. It can also provide tax benefits and lower the cost of capital compared to equity financing.
What are the steps in a defeasance? The steps in a defeasance typically include establishing a defeasance account, purchasing a portfolio of government securities, verifying compliance with loan agreement terms, notifying the lender, and coordinating the release of the property from the original loan.
What is loan acceleration? Loan acceleration refers to the lender’s right to demand immediate repayment of the entire outstanding balance of a loan if the borrower violates specific terms or conditions outlined in the loan agreement.
What are the top 3 financial risks? The top three financial risks often cited are credit risk (default risk), market risk (price risk), and operational risk (risk of loss due to internal processes or systems).
Which loan has the highest risk? Loans with higher interest rates, variable interest rates, or loans issued to borrowers with lower credit scores typically carry higher risk for lenders.
Which type of loan is riskier to the lender? Unsecured loans, which are not backed by collateral, are generally riskier to lenders because they have no specific assets to claim in case of borrower default.
What does bond defeasement mean? Bond defeasement refers to the process of setting aside sufficient funds or assets in a trust to meet the future payment obligations of bonds, ensuring that the bonds will be paid off as they mature. This reduces the issuer’s liability for the bonds.
Why not buy CMBS? The decision to buy or not buy Commercial Mortgage-Backed Securities (CMBS) depends on various factors, including the investor’s risk tolerance, investment goals, and market conditions. CMBS can carry risks related to credit quality and market volatility, so investors should carefully assess these factors before making a decision.
What is an ABS loan? An ABS (Asset-Backed Security) loan is a type of loan where the borrower’s repayments are backed by specific assets, such as accounts receivable, inventory, or equipment. These loans are often packaged into securities and sold to investors.
What is the difference between CLO and CMBS? A CLO (Collateralized Loan Obligation) is a type of structured financial product that primarily consists of loans made to corporations. CMBS, on the other hand, consists of loans secured by commercial real estate properties. The underlying assets and risk profiles are different between the two.
What is 2% of loan amount points? “2% of loan amount points” likely refers to a fee that is equal to 2% of the loan amount. This fee may be charged by a lender as part of the loan origination process.
What does 20 points on a loan mean? “20 points on a loan” would typically mean that the borrower is paying a fee equal to 20% of the loan amount as part of the loan agreement. This is a significant fee.
How much is 5 points on a loan? “5 points on a loan” would mean that the borrower is paying a fee equal to 5% of the loan amount as part of the loan agreement.
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