With commercial real estate loans borrowers typically cannot prepay an outstanding loan without incurring a prepayment penalty. Defeasance is a form of prepayment penalty for conduit loans redeemed prior to maturity. Defeasance literally means taking a “feasance,” or mortgage/deed of trust, off real property.

A more technical answer is defeasance is a substitution of collateral via a process through which a borrower is released from the obligations associated with its loan through the purchase of a portfolio of U.S. Government Securities. These securities serve as replacement collateral to secure the loan and generates the cash flows required to repay the loan through the scheduled maturity or earlier optional prepayment date.

The defeasance process is the process whereby the original Borrower and the real estate collateral are released from the CMBS loan and a successor borrower and securities collateral are substituted instead. The Securities must be adequate to ensure the timely payment under the loan. By accomplishing defeasance, the Borrower is free to sell or refinance the real property.

It is also important to mention what defeasance is not – a payoff of the loan. The note actually remains in place, and debt-service payments are made as scheduled to the loan’s maturity date. The process generally takes about 30 days and involves several parties, including attorneys, accountants, a loan servicer, and possibly rating agencies.

Below is an overview of a standard defeasance transaction, however, it does not purport to set forth all the terms and conditions. Your own defeasance transaction may vary from this description. In its simplest terms, a defeasance transaction looks like this: