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Feb 01, 2005

The commercial cornerJerry Feinstein prepayment penalty, commercial loan, prepayment terms The Mortgage Press is pleased to present "The Commercial Corner," a monthly column by Jerry Feinstein of Silver Hill Financial LLC dedicated to answering your questions about the commercial mortgage marketplace. If you have a question that you would like answered in a future installment of "The Commercial Corner," e-mail [email protected]. It seems that most commercial loans have some type of prepayment penalty. Is this true? Yes, penalties are installed due to the nature of the commercial mortgage-backed securities market and commercial funding sources. The vast majority of commercial mortgages have a mechanism to compensate the lender/investor for an early prepayment. Why are prepayment penalties uncommon on conforming residential mortgages but common on commercial mortgages? Several factors drive this trend, but the primary one is economics. In the conforming residential world, there isn't enough value for both the borrower and investor to create a prepayment penalty structure that works. Can you explain some of the terms used for prepayment penalties on commercial loans? The three most common terms are "yield maintenance," "defeasance," and a "straight line" or "declining percentage." Keep in mind that there may be variations between lenders, but the basics are as follows when the borrower prepays: *Yield maintenance: The lender collects a lump sum from the borrower based on a formula that considers the present value of the difference between the prepaid loan's interest rate and current rates with a similar maturity date. *Defeasance: The borrower is required to purchase and deposit with the lender substitute collateral, such as a Treasury security that matches the principal and interest payments of the prepaid loan and thereby sufficiently services the debt of the prepaid loan. *Straight line or declining percentage: The borrower pays a lump sum based on a percentage of the outstanding principal balance at the time of prepayment. The percentage may be the same for a period of time, such as five percent for five years, or it may decline, such as five percent for year one, four percent for year two, three percent for year three, etc. How big of an impact do the different prepayment methods have on the borrower? The impact can be significant. This is why it is important to understand the prepayment terms associated with various commercial loan offerings, and just as important, the potential monetary impact these prepayment penalties could have on your borrowers. Jerry Feinstein is director of business development for Silver Hill Financial LLC. He may be reached by phone at (877) 676-1562 or e-mail [email protected].
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Feb 01, 2005
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