Prepayment Penalty
A prepayment penalty compensates the lender for interest lost when a commercial loan is paid off early. Common structures include step-down penalties (e.g., 5-4-3-2-1% of balance by year), yield maintenance (the present value of remaining interest), and defeasance (substituting bonds as collateral). Most commercial loans carry one.
Yield maintenance and defeasance can be startlingly expensive when rates have fallen — sometimes 10% or more of the balance — because the penalty makes the lender whole on every remaining payment.
Prepayment structure matters most for owners likely to sell or refinance early. A slightly higher rate with a soft step-down often beats a lower rate with yield maintenance for a short expected hold.