What is defeasance?
In the context of a mortgage loan, defeasance is a substitution of collateral. A mortgage loan borrower purchases a basket of securities, the proceeds of which will be sufficient to make all of the remaining interest and principal payments on the mortgage loan. The borrower then pledges this basket of securities to the mortgage lender. In return, the mortgage lender releases the mortgage on the borrower's real estate and releases the borrower from its obligations under the mortgage loan. The borrower is then free to sell or refinance the real estate, unencumbered by the defeased mortgage.
May I prepay my loan instead of defeasing it?
Consult your loan documents. In some cases in which the loan documents offer a defeasance option, the borrower also has the option of prepaying the loan, subject to a yield maintenance premium. In most cases, if defeasance is presented in the loan documents, it is the only option provided by the lender for the discharge of the borrower's obligations prior to maturity.
What is the cost of defeasance?
The cost of defeasing your loan will consist of two sets of components. The first set comprises the various costs associated with documenting and processing the defeasance. While these costs will differ from loan to loan, they are not sensitive to the timing of the defeasance itself.
The second set of costs are the prices of the securities to be pooled and offered as defeasance collateral, which are highly sensitive to interest rate fluctuations over time. Acceptable securities include noncallable U.S. Treasury obligations and, in some cases, noncallable obligations of agencies such as Fannie Mae and Freddie Mac. If interest rates decrease, these securities become more expensive. If interest rates increase, these securities become less expensive.
What types of securities are acceptable as defeasance collateral?
Noncallable U.S. Treasury obligations are acceptable substitute collateral. In some cases, other noncallable debt issues that are not direct obligations of the Treasury, such as securities issued by Fannie Mae and Freddie Mac, will be acceptable as defeasance collateral. These securities may offer higher yields and thereby reduce the overall cost of the defeasance. Defeasance Management LLC will work with your loan servicer to determine what securities are acceptable in order to minimize the cost of your defeasance.
How long will it take to defease my loan?
Your loan documents will provide the mortgage lender's notice requirements for defeasance. In most cases, Defeasance Management LLC will be able to work with your loan servicer to waive the notice period in order to expedite your defeasance. The actual defeasance closing process requires three business days, once all servicer requirements have been met.
What is the three-day closing process?
A defeasance closing takes place over a period of three business days in order to ensure that the securities in the defeasance collateral portfolio are purchased and delivered on time.
The requirements for closing the defeasance and all associated transactions, including any sale or refinance of the real estate, must be completed as of the morning of Day 1. All paperwork must be completed and signed and all other transaction requirements must be satisfied at this time. The required securities are identified and purchased on behalf of the borrower on Day 1.
On Day 2, Defeasance Management LLC confirms the physical receipt of the securities purchased on Day 1. The defeasance accountant will provide verification on Day 2, if not earlier, that the securities are sufficient to defease the mortgage loan.
On the morning of Day 3, the securities are wire transferred to the account of the custodian responsible for holding the securities and making the mortgage loan payments from their proceeds for the rest of the life of the loan. All fees associated with the defeasance are wired to the appropriate parties. Upon confirmation that the securities have been delivered and all fees have been paid, the loan servicer will authorize the release of the mortgage on the real estate on Day 3.
What is the risk associated with the purchase of the defeasance securities?
If the borrower authorizes the purchase of the defeasance securities on its behalf and the defeasance does not occur, the borrower will be liable for breakage fees connected to the failure to take delivery of the securities from the securities dealer and potential losses incurred by the securities dealer in the resale of the securities. This risk is eliminated if all transactional requirements are satisfied on Day 1, prior to the purchase of the defeasance securities.
