Yield Maintenance (YM) Definition

IN THIS GUIDE

What is yield maintenance?

Yield maintenance is used by lenders as a prepayment penalty. This guarantees the lender all the scheduled interest payments. Lenders issue yield maintenance to safeguard the loan’s expected return on investment. This is seen as a safeguard as the yield maintenance places the responsibility of lost income from interest on the borrower.

How to calculate yield maintenance?

Calculation variables:

  • Interest rate
  • Treasury yield
  • Remaining balance
  • Total payments remaining
  • Number of annual payments
  • Present value of the remaining balance.

Example

A real estate investor in San Francisco is looking to pay off his loan’s remaining balance with 3 years remaining. The investor was issued a 10-year at a 7% interest rate with a remaining balance of $1M. The investor goes to the U.S. Department of the Treasury website and sees that the 3-year treasury yield is at 1.5%. PV of Balance = 1 – (1 + treasury yield) ^ (-total payments left / annual payments) * remaining balance PV of Balance = 1 – (1 + .015) ^ (-36 / 12) * $1M PV of Balance = $2,912,200 Yield Maintenance = Present Value of Remaining Balance * (Interest Rate – Treasury Yield) Yield Maintenance = $2,912,200 * (7% – 1.5%) Yield Maintenance = $2,912,200 * 5.5% Yield Maintenance = $160,171

What does a $160,171 yield maintenance mean?

The investor will face a prepayment fee of $160,171 in order to pay off the loan within the YM period.

Why does a 5.5% yield maintenance make sense for the lender?

The investor will only pay a 5.5% interest rate for his remaining balance as the lender will be able to invest the funds into a 3-year treasury to make up for the other 1.5% in interest.

How can investors avoid the yield maintenance fee?

As long as the investor pays off his loan after the agreed upon yield maintenance period, the investor will not be charged any prepayment fees.

Example

A real estate investor from Dubai is looking to pay off a loan’s remaining balance in year 7. The investor was issued a 10-year, $2M loan at a 6% interest rate with an 8-year yield maintenance period. If the investor pays off the loan in year 7, the loan is still within the 8-year yield maintenance period. To avoid the yield maintenance fee the investor should wait an additional year as the loan will then be out of the 8-year yield maintenance period.

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