Yield Maintenance

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Yield Maintenance

Yield Maintenance (YM) is a prepayment premium that allows the lender (generally a life insurance company) to attain the same yield as if the borrower made all scheduled mortgage payments until maturity. Yield maintenance premiums are designed to make the lender indifferent to prepayments. This penalty makes refinancing unattractive and uneconomical to borrowers.

So how do you calculate it?
YM = PV of Remaining Mortgage PMTs x (Interest Rate – Treasury Rate)

If current market interest rates are lower than loan interest rate then the yield maintenance premium will be positive. If market rates are higher than loan interest rate then the formula returns a zero premium. However, the lender usually writes a second test with a fixed percentage of the outstanding loan balance so it ends up with a premium in its pocket anyway (generally 1%). Some lenders use a sliding percentage of the principal to calculate the premium. Floating rate loans can have spread maintenance premiums and both types of loans can have prepayment lock out periods where any prepayment is prohibited.

Two other prepayment penalties include defeasance and fixed percentage. Find out more about prepayment penalties on our blog post: Restrictions on Prepayment.

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