Defeasance is a mechanism that substitutes U.S. Treasuries for real estate collateral so a borrower can release property from a CMBS or mortgage loan.
Defeasance is a structured prepayment mechanism used primarily in commercial mortgage-backed securities (CMBS) and other fixed-rate loan agreements that allows a borrower to replace the mortgage collateral with a portfolio of government securities that replicates the loan’s remaining cash flows. By purchasing and delivering those securities to the lender or trustee, the borrower effectively transfers the income stream backing the loan so the mortgage can be released without accelerating the loan or triggering other penalties. The process requires precise securities selection, legal documentation, and trustee approval.
When a sponsor wants to refinance or sell a property subject to a CMBS or defeasible mortgage, model defeasance by estimating the cost of the Treasury strip portfolio needed to match scheduled principal and interest, along with trustee, legal and ancillary fees. Coordinate timing with the servicer and trustee to allow for delivery windows and any required prepayment notices. Compare defeasance to cash prepayment, yield maintenance, or negotiated payoffs to determine the lowest total cost and the most efficient path to release the collateral and execute a refinance or sale.
Defeasance is important because it provides a legally recognized means for borrowers to remove property from a secured loan while preserving the lender’s expected cash flows, enabling sales or refinancings that otherwise would be blocked by restrictive loan terms. For lenders and bondholders, defeasance maintains yield integrity. For borrowers and brokers, defeasance can be costly and operationally complex, so understanding the mechanics, timing, and full cost is essential to determine whether defeasance, yield maintenance, or other prepayment alternatives deliver the most favorable economic outcome.