Breakage cost is the expense of terminating interest rate hedges early; it factors into prepayment and refinance calculations for CRE loans.
Breakage cost refers to the expense incurred when a lender or borrower terminates an interest rate hedge, swap, cap, or other derivative before its scheduled maturity. In commercial real estate lending, prepaying a fixed-rate loan or restructuring a floating-rate facility often forces the associated hedges to be unwound, producing a cash settlement that can be positive or negative depending on market rates. Lenders typically pass through breakage costs to borrowers as part of prepayment charges, and these costs can materially increase the economic cost of an early payoff or recapitalization.
When evaluating refinancing or early payoff options, ask for a breakage cost estimate and include it in your payoff calculations along with customary prepayment provisions like yield maintenance or defeasance. Coordinate with the lender to understand which hedges the lender will unwind and whether the cost is passed fully to the borrower. Use breakage cost estimates to compare the net benefit of changing capital structure versus staying in place, and consider negotiating partial hedge assignments or other arrangements to reduce upfront cash settlements when feasible.
Breakage costs are important because they can substantially increase the cash required to terminate a loan or change hedging arrangements, altering the feasibility of refinancing, sale, or recapitalization. For borrowers, unexpected breakage charges can consume expected arbitrage gains from a lower-rate replacement loan. For lenders and servicers, accurate breakage calculation protects hedging positions and investor returns. Understanding breakage costs is thus essential to sound exit planning, accurate pro forma modeling, and negotiating loan terms that align with the sponsor’s intended flexibility.