Most CMBS conduit loans feature defeasance as the method for loan prepayment before maturity (click here for details). Several well-qualified firms handle the defeasance process on behalf of borrowers, and each has a defeasance calculator on its website.
Let’s walk through an example of how to use the defeasance calculator at defeasewithease.com. Click on the “Defeasance Calculator” tab to begin. Let’s assume we want to estimate the cost to pay off a $5-million loan expected to close on February 1, 2020 in 5 years. The loan has a 10-year term, 5 years interest-only and then a 30-year amortization period.
Here are the inputs:
- Servicer: Select “Wells Fargo” if you do not know who the loan servicer is;
- Original Loan Amount: $5,000,000;
- Loan Term: 120;
- Interest Only: 60;
- Amortization: 360;
- Interest Rate: 4% (enter the expected interest rate for the loan at closing);
- Interest Calculation: Select “Actual/360”;
- Payment Day of Month: Leave as “1st”;
- Note Dated: Enter the 1st day of the month after expected loan closing, “2/1/20”; and
- Defeasance Date: Enter 5 years from closing date “2/1/25.”
Deselect “Please contact me” and click on “Disclaimer” and “calculate.” The result is “Total Estimated Defeasance Cost” of $5,542,020.49. You must subtract the current loan balance to determine the amount of premium to be paid by the borrower to defease the loan, in this case $542,020.49.
Now the result may look very high, but keep in mind that interest rates are very low right now. To get a better picture of the defeasance costs, click on the Defeasance Sensitivity Calculator. At the bottom, input 100 in the “Basis Point interval to be calculated” and click on “calculate.” The results are for interest rates rising 1%, 2% and 3% at the time of prepayment. Note that if interest rates rise 3%, you will receive a payment of $128,820.26 to prepay the loan.