The Ins and Outs of Defease Loans


Welcome to our comprehensive guide on defease loans! If you’re a real estate investor or owner, you might have encountered this term before. But what exactly is a defease loan? In simple terms, it’s a type of commercial mortgage-backed security (CMBS) loan where the borrower can pay off the mortgage without penalty or prepayment fees at a specific point in the loan term, usually at maturity. This effective strategy strives to minimize the risk of default by the lender while providing flexibility for the borrower. In our extensive research, we’ve uncovered everything you need to know about defease loans, so let’s dive in.

What is a Defease Loan?

A defease loan is a form of commercial real estate mortgage that arranges an interest-bearing portfolio of government securities to offset the loan risk. The borrower enters into an agreement to purchase government securities with the cash flow from the underlying collateral. In case of default, the lender can still receive its repayments from the government securities, securing their investment. This arrangement allows the borrower to pay off the loan without prepayment penalties at a specific point in time, usually at maturity. The borrower can effectively defease the loan, transferring the risk to the securities portfolio.

Benefits of Defease Loans

One of the significant benefits of defease loans is the flexibility they provide borrowers. Conventional commercial real estate loans typically come with hefty prepayment penalties, making it challenging for borrowers to pay off the mortgage before maturity. With defease loans, borrowers can pay off the loan early without incurring any penalties, giving them increased financial freedom. Defeasance is also a means of risk transfer, allowing for a more diversified investment portfolio that can mitigate risk with government securities.

The Defeasance Process

The defeasance process involves purchasing a portfolio of highly creditworthy, interest-bearing obligations such as government bonds to offset the outstanding balance of the mortgage loan. This portfolio is placed in a trust and managed by a trustee until the loan is paid off. This process transfers the risk of the loan to the portfolio of securities while freeing up the borrower’s collateral for other investments. The trustee ensures that the borrower complies with all the rules and regulations of the defeasance agreement, so the lender’s investment is secure.

Defeasance vs. Prepayment Penalty

As mentioned earlier, the most significant advantage of defease loans is the lack of prepayment penalties. Traditional commercial real estate loans impose penalties on borrowers for paying off their loans before the due date. These penalties can be as high as six months of interest payments, making it challenging for borrowers to refinance or pay off their debts early. Defeasance, on the other hand, allows borrowers to pay off the mortgage without prepayment penalties and adds more flexibility and predictability to the investment process.

When to Consider a Defease Loan

A defease loan might be the right option for borrowers who seek flexibility and want to avoid early prepayment penalties. This loan type can be suitable for those looking to sell their property or refinance, as they can defease the loan and avoid the prepayment penalty. Additionally, defease loans work well for portfolios with multiple properties, allowing borrowers to sell individual properties and pay off the corresponding loan without penalty or refinancing the remaining mortgage.

Defeasance Cost

Defeasance costs depend on various factors, such as the loan balance, the interest rate, and the bond portfolio’s duration. Generally, the cost of defeasance is about 1% to 2% of the loan balance. However, this cost may vary depending on the duration of the bond portfolio and the interest rate environment at the time of defeasance. Thus, it’s essential to work with a knowledgeable defease loan expert who can help you navigate the process and provide accurate cost projections.

Defease Loan Table

Defease Loan
A type of CMBS loan that allows the borrower to pay off the mortgage without prepayment penalties.
Risk Transfer
A strategy that mitigates the risk of the lender by transferring it to a securities portfolio, allowing for more diversified investments.
Defeasance Process
The process of purchasing a portfolio of highly creditworthy, interest-bearing obligations to offset the outstanding balance of the mortgage loan.
Prepayment Penalty
A penalty imposed on the borrower for paying off a loan before the due date, typically six months of interest payments.
Benefits of Defease Loans
Flexibility, no prepayment penalties, diversified investments, and risk mitigation are some of the significant advantages of defease loans.
When to Consider a Defease Loan
Defease loans might be the right option for borrowers who want flexibility, are looking to sell or refinance their property, or have portfolios with multiple properties.
Defeasance Cost
The cost of defeasance depends on factors such as loan balance, interest rates, and portfolio duration, and may range from 1% to 2% of the loan balance.


1. How is defeasance different from a traditional prepayment penalty?

Defeasance allows for the repayment of the loan at maturity without any prepayment penalties. In contrast, traditional prepayment penalties can be as high as six months of interest payments.

2. Can you defease any type of commercial loan?

No. Only commercial real estate mortgage loans that meet specific criteria are eligible for defeasance.

3. What happens to the securities portfolio after the mortgage is paid off?

The securities portfolio can be liquidated, and the proceeds can be used for other investments.

4. Can a defease loan be refinanced?

Yes, a defease loan can be refinanced using traditional refinancing methods or an additional defease loan.

5. How long does the defeasance process take?

The defeasance process typically takes between 30 and 60 days to complete.

6. Who manages the securities portfolio?

The securities portfolio is managed by a trustee appointed by the borrower.

7. Are there any drawbacks to defease loans?

While defease loans offer significant benefits, they may not be suitable for all borrowers. There are costs associated with defeasance, and the process can be complicated. Additionally, the borrower needs to have the necessary funds to purchase the bond portfolio. Defeasance loans may also have higher interest rates than traditional commercial loans.

8. Can a borrower sell their property after defeasance?

Yes, a borrower can sell their property after defeasance. If the borrower sells the property, the remaining loan must be paid off using the funds from the sale.

9. Can a borrower pay off the loan before maturity using traditional methods?

Yes, a borrower can pay off a defease loan before maturity, but they will incur prepayment penalties. Defease loans are designed to allow for penalty-free repayment at maturity.

10. Who determines the cost of the bond portfolio?

The cost of the bond portfolio is determined by the current market conditions at the time of the defeasance.

11. What happens if the borrower defaults on the bond portfolio?

If the borrower defaults on the bond portfolio, the lender can seize the securities to recoup their losses.

12. Can a defease loan be used for residential properties?

No, a defease loan is only available for commercial real estate mortgage loans.

13. Can a borrower choose their own bond portfolio?

The borrower can choose their own bond portfolio, but the securities must meet specific criteria to be eligible for defeasance.


Defease loans offer borrowers a flexible and cost-effective way to manage their commercial real estate investments. With the ability to pay off loans without prepayment penalties, this loan type allows borrowers to reduce their risk and increase their financial freedom. However, the defeasance process can be complicated, and the costs may vary. Thus, it’s crucial to work with a knowledgeable defease loan expert who can guide you through the process and provide accurate cost projections. If you’re considering a defease loan for your portfolio, we hope this guide provides you with valuable information to make an informed decision.

Closing Disclaimer

The information provided in this article is for educational purposes only and should not be considered legal or financial advice. The author and publisher are not liable for any losses or damages arising from the use of this information. Always consult with a legal or financial professional before making any investment decisions.