Defeasance Clause
In real estate, defeasance refers to a legal process by which a borrower or property owner satisfies and extinguishes a mortgage lien or security interest by providing an alternative form of collateral to the lender.
Defeasance allows the borrower to release the property from the mortgage obligation while maintaining the lender’s security interest through the substitution of assets, typically in the form of government securities or bonds.
Key aspects of defeasance in real estate include:
1. Purpose: Defeasance is commonly used in commercial real estate financing to facilitate the release of a property from a mortgage lien or security interest. It allows borrowers to pay off their mortgage debt without selling the property by providing an alternative form of collateral to the lender.
2. Substitution of Collateral: In a defeasance transaction, the borrower replaces the real property serving as collateral for the mortgage with other assets, usually in the form of highly liquid and low-risk government securities, such as Treasury bonds or agency securities. These securities are typically held in a trust or escrow account for the benefit of the lender.
3. Prepayment of Debt: By providing alternative collateral through defeasance, the borrower effectively pre-pays the remaining balance of the mortgage debt. The income generated from the securities held in the trust or escrow account is used to make the scheduled mortgage payments on behalf of the borrower until the loan term expires or is paid off.
4. Release of Lien: Once the lender receives confirmation that the trust or escrow account has been funded with sufficient securities to cover the remaining mortgage debt, the lender releases the mortgage lien or security interest on the property. The property is then free from the encumbrance of the mortgage, allowing the borrower to retain ownership and control.
5. Legal Process: Defeasance transactions involve legal documentation and agreements between the borrower, lender, and trustee overseeing the defeasance process. These documents outline the terms and conditions of the defeasance, including the establishment of the trust or escrow account, the selection and purchase of the replacement securities, and the release of the mortgage lien upon satisfaction of the defeasance requirements.
6. Costs and Considerations: Defeasance transactions may involve costs and expenses, including fees for legal counsel, trustees, and administrative services. Borrowers should carefully consider the financial implications and requirements of defeasance before proceeding with this option to release their property from a mortgage lien.
Overall, defeasance provides a structured and legally compliant mechanism for borrowers to satisfy mortgage obligations and release properties from mortgage liens or security interests without selling the property. By substituting collateral with alternative assets, borrowers can achieve debt repayment while retaining ownership and control of their real estate assets.