How does commercial loan prepayment penalty work?

Most commercial loans include prepayment penalties to protect lenders from losing expected interest income when a loan is paid off early. Common prepayment structures include: step-down penalties (e.g., 5-4-3-2-1, meaning 5% penalty in year 1, declining by 1% each year), yield maintenance (paying a fee equal to the present value of remaining interest payments at a specified rate), and defeasance (replacing the loan collateral with government securities that generate the same cash flows). CMBS loans almost universally require defeasance or yield maintenance, which can cost millions of dollars. Always understand the prepayment structure before committing to a commercial loan.