Yield maintenance is a prepayment fee calculated on the movement of interest rates over the period of time securities are held. The formula considers the present value of outstanding payments and helps investors secure a reasonable rate of return on commercial mortgages.
Yield maintenance is a form of prepayment fee or premium that is calculated on the movement of interest rates over the period of time the security or securities in question are held. The lender evaluates the performance of the maintenance by the lender. In general, the anticipation that security will provide higher performance as a result.
Perhaps the best illustration of how yield maintenance works is in the commercial mortgage market. The mortgage underwriter will base the Yield Maintenance Rate on both current interest rates and projected rates that may apply over the life of the mortgage. The formula for determining the applicable yield maintenance involves considering the present or present value of the outstanding payments associated with the mortgage. This figure is multiplied by the difference between current rates on Treasury bonds of the same duration and the interest rate on the bonds involved with the mortgage.
The value to investors is that yield maintenance helps ensure that the investment return will remain the same, even if the borrower chooses to participate in some type of repayment process that is different from the scheduled payment structure. From this perspective, yield maintenance makes it possible for the investor to secure a reasonable rate of return on the commercial mortgage.
Because the yield maintenance calculation has to do with interest rates, the strategy is often used in the valuation of securities. Projecting the sustained return on a given security investment is one way that potential investors can assess the feasibility of becoming involved with the security, as the calculation will help reveal the potential to generate a return. Although yield maintenance will fluctuate slightly due to changes in the amount of payments outstanding, adjusting to show the current rate of yield maintenance is relatively easy to achieve and helps provide evidence that an investment is performing as expected.
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