Yield Maintenance

Moneybestpal Team
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Yield maintenance is a formula that calculates the present value of the remaining interest payments on a loan, assuming that the loan is paid off at the current market interest rate. The formula considers the initial interest rate, the current interest rate, the outstanding loan balance, and the remaining loan period.

In the event that the borrower decides to refinance or sell the property before the loan matures, yield maintenance is intended to prevent the lender from losing out on the anticipated interest income from the loan. The lender makes sure they get the same amount of interest revenue as if they held the loan to maturity by assessing a yield maintenance fee.

Typically, fixed-rate loans with lengthy durations, like 10 or 15 years, use yield maintenance. These loans typically feature higher prepayment penalties but lower interest rates than shorter-term loans. When the current market interest rate is significantly lower than the initial interest rate, yield maintenance costs can be highly costly.

Consider a $1 million loan with a 15-year fixed rate and a 5% interest rate that you want to pay off in five years. With 10 years left on the loan's duration, the outstanding balance is $865,000. A comparable loan currently has a 3% market interest rate. You would be required to pay a fee of $139,000 to payback your loan according to the yield maintenance formula. This cost is the distinction between the present value of your future interest payments at 5% and 3%.

You can see that for borrowers who desire to pay off their debts early, yield maintenance can be a major expense. Thus, when you sign your loan agreement, it is crucial that you comprehend how yield maintenance functions and how it affects it. When selecting a loan that meets your needs and goals, you should also examine several loan possibilities and take into account variables like interest rate, loan length, amortization plan, and prepayment penalty.