What Is the Defeasance Process?

The defeasance process is a means by which borrowers can replace the collateral used on a mortgage loan with another asset or substitute collateral—usually a portfolio of 澳洲幸运5官方开奖结果体彩网:government bonds backed by the U.S. Treasury.

Typically, the collateral on a mortgage is the home or property. The securities used as a substitute for the collateral must be of sufficient value to generate enough 澳洲幸运5官方开奖结果体彩网:cash flow to cover the remaining 澳洲幸运5官方开奖结果体彩网:principal and interest owed on the loan. The defeasance proc🦹ess can also be used in other kinds of financial transactions. Discover how defeasance works with mortgage loans.

How the Defeasance Process Works

With defeasance, the debt obligation does not go away, but the defeasance process releases the mortgaged property’s title to the borrower. The process allows the borrower to 澳洲幸运5官方开奖结果体彩网:refinance or sell the property befor🅰e the❀ mortgage loan has been fully paid off.

澳洲幸运5官方开奖结果体彩网:Defeasance clauses are common in certain types of mortgage contracts, particularly those in states that follow what is known as title theory. Title theory states that the lender holds title to the property until the mortgage ends, at which point the property belongs to the borrower. In other states, borrowers acquire title to the property right away, but the lender holds a lien against it in case the borrower defaults on the loan.

Steps in the Defeasance Process

If your mortgage contai💧ns a defeasance clause, it should specify how to proceed. The process begins with the borrower sending a notice of intent for defeasance to the mortgage lender or loan servicer who prepares the necessary legal document♔s, which includes the defeasance close date.

The borrower will, of course, need to purchase the alternative collateral to use as a replacement collateral unless they already have it. Typically, the interest return on the 澳洲幸运5官方开奖结果体彩网:bonds needs to generate enough ca🌟sh flow to meet the loan payment obligations of principal and interest.

In more complicated instances—such as 澳洲幸运5官方开奖结果体彩网:commercial real estate—the borrower will generally need to obtain the legal and financial services of specialists well-versed in the defeasance process. That’s because the defeasance will require creating new entities, such as a successor borrower who holds 澳洲幸运5官方开奖结果体彩网:the bonds in a special account and transfers the 澳洲幸运5官方开奖结果体彩网:bond interest payments to the lender or mortgage servicer to satisfy the loan payments.

The closing may take a few days since it includes the borrower obtaining the substitute collateral and transferring 澳洲幸运5官方开奖结果体彩网:the bonds to an escrow account. Once the defeasance process has been completed,♎ the lien on the property is released, and the subs🐻titute collateral secures the loan.

The number of parties involved and the cost of defeasance will vary, as laws governing the process differ from state to state. The process will typically take 30-45 days.

Defeasance and Securitized Loans

Defeasance originated in the bond market as a way to help ensure that investors would receive their expected yields in the event that the bond issuer decided to prepay its obligations to its bondholders. However, defeasance became popular in the world of real estate financing when mortgage 澳洲幸运5官方开奖结果体彩网:securitization took off.

Securitized loans are generally held by entities known as 澳洲幸𒆙运5官方开奖结果体彩网:real estate mortgage investment conduits🎉 (REMICs). These entities operate under a controlled list of rules set forth by the 澳洲幸运5官方开奖结果体彩网:Internal Revenue Code, which 🦩specify the conditions that a borrower must meet to qualify for defeasance.🌳

The first rule prohibits defeasance if the mortgage is less than two years old. The rules define the day when the loan was sec🗹uritized as the beginning of the two years rather than the day when the loan was closed. Some loans will specify ܫthat the loan must be even older than two years for defeasance.

The rules also state that the loan documents must explicitly permit the borrower to seek defeasance. Documents may not be amended later to allow for defeasance. The securities used as new collateral typically must be government securities, which are considered to represent the lowest risk for investors. Finally, the mortgage against the property may only be released to facilitate the 澳洲幸运5官方开奖结果体彩网:disposition of the property, such as through selling or𒈔 refinancing.

The Bottom Line

The defeasance process is when a borrower substitutes securities, such as government bonds, for the existing collateral on their mortgage loan, which is usually the home. The income from the bonds must be adequate to cover the loan payments. It's important to review your mortgage loan documents since not all mortgage loans allow defeasance.