Calculate the yield-maintenance premium that would erase a lower coupon’s savings at each planned exit date.
When one loan charges a higher coupon for a known step-down premium and another offers a lower coupon with yield maintenance, calculate the maximum future yield-maintenance premium that would preserve the lower-rate loan’s advantage. That threshold is more useful than declaring either mechanism universally cheaper.
The premium itself must still come from the actual contract and a properly dated calculation. This example treats future yield-maintenance amounts as scenario inputs; it does not substitute a generic formula for the signed documents.
Compare two fully specified hypothetical offers
Both proposals fund $5 million, remain interest only, and charge $50,000 upfront. The owner is considering a sale in either loan year two or loan year four. Both payoffs are assumed permitted after the required notice.
Step-down proposal S charges 6.50%. Its invented schedule applies 5%, 4%, 3%, 2%, and 1% to outstanding principal in loan years one through five. Yield-maintenance proposal Y charges 6.25%. Its payoff premium is calculated under a separate assumed contractual mechanism, with the actual future result unresolved.
For the illustration, “end of year two” means a designated payoff date still subject to the 4% rate; “end of year four” means a date still subject to 2%. The exact anniversary boundary must be verified in actual documents. Moving a payment one day can cross a contractual period, so informal calendar labels are insufficient for a real payoff.
Fannie Mae’s declining-premium term sheet illustrates that schedules and lockouts vary by selected product. The schedule here is stipulated for arithmetic; the article does not combine features from different Fannie Mae products into a proposed loan.
Calculate the threshold at each sale date
Y saves 0.25 percentage points annually on $5 million, or $12,500 per year. With identical initial fees and principal balances, its allowable additional prepayment cost equals those accumulated interest savings.
| Payoff date | S premium | Y interest savings to date | Y premium producing equal nominal total cost |
|---|---|---|---|
| Year two, 4% step-down period | $200,000 | $25,000 | $225,000 |
| Year four, 2% step-down period | $100,000 | $50,000 | $150,000 |
At year four, Y remains cheaper only if its premium is below $150,000, assuming every other stated cost remains equal. The threshold is not simply S’s $100,000 premium because Y has already saved $50,000 of interest.
At year two, the threshold is higher: $225,000. The step-down charge is larger even though less coupon saving has accumulated. A borrower cannot transfer the year-two threshold to a year-four sale without recalculating both components.
Test the premium uncertainty against the threshold
For a year-four payoff, consider hypothetical Y premium estimates of $50,000, $150,000, and $350,000. They are sensitivity inputs, not current quotes or predictions for particular Treasury yields.
| Year-four financing expense | S | Y: $50,000 premium | Y: $150,000 premium | Y: $350,000 premium |
|---|---|---|---|---|
| Four years of interest | $1,300,000 | $1,250,000 | $1,250,000 | $1,250,000 |
| Initial fee | $50,000 | $50,000 | $50,000 | $50,000 |
| Payoff premium | $100,000 | $50,000 | $150,000 | $350,000 |
| Total expense | $1,450,000 | $1,350,000 | $1,450,000 | $1,650,000 |
The range moves Y from $100,000 cheaper to $200,000 more expensive than S. Principal repayment is excluded because it is the same $5 million in each column; actual sale proceeds must still deduct it. Accrued interest and other payoff charges must be reconciled to the modeled payment date.
No probability is assigned to the three premiums. A borrower making the decision today should evaluate its ability to absorb the expensive outcome and the value of the rate concession, rather than pretending the midpoint is an expected quote.
Obtain the inputs from the correct document generation
Fannie Mae’s Finding Prepayment Terms job aid distinguishes where relevant terms appear in older and newer loan documents, including the prepayment type, notice, ending date, percentage, and yield-rate inputs. It also cautions that non-Fannie documents may differ.
Use that as a source-location lesson, not a universal calculation rule. For the subject loan, retain the signed note, agreement, schedules, and amendments and identify the exact premium provision. Ask the servicer or authorized calculation party to confirm the balance base, calculation date, remaining protected period, benchmark, minimum premium, and any additional charges.
A document title such as “yield maintenance” does not establish how the formula works. Nor does a negative result in a simplified present-value model establish a borrower credit. The contract may include a minimum or another binding calculation. Use actual source language and a transaction-specific calculation before moving from sensitivity analysis to settlement.
Adapt the threshold when other terms differ
If Y charges $20,000 more upfront, its year-four threshold falls from $150,000 to $130,000. If its lower coupon applies to an amortizing balance, calculate the actual interest difference from the two schedules rather than multiplying the original principal by four years.
If the borrower plans a partial payoff, determine the permitted payment amount and premium base first. If one loan has a lockout at the intended date, there is no ordinary voluntary-payoff price to compare until the actual permitted alternative is established.
The finished decision record should state the threshold, the evidence supporting the premium range, and the dates that change the result. A known step-down schedule can provide useful cost visibility. A lower-coupon yield-maintenance loan can also be economical. The tradeoff becomes clear only after the rate concession and the future exit charge are measured together.
Sources and evidence
- Fannie Mae — Declining Prepayment Premium Term SheetFixed-Rate and SARM Declining Prepayment Premium Structures · Checked 2026-10-21 · Product-specific schedules and lockouts differ; actual executed terms and current lender confirmation govern.
- Fannie Mae — Finding Prepayment TermsWhere to Find Prepayment Terms · Checked 2026-10-21 · Legacy servicing job aid distinguishes document generations and input locations; not a universal premium formula or current payoff quote.
Source dates and applicability matter. Report an error or a changed source.