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Defeasance refers to the process whereby the legal title of a property is transferred back to the borrower after full repayment of the loan.
It can exist as a defeasance fee in commercial mortgages which is a prepayment penalty that the borrower has to pay in the event of full repayment before the maturity of the loan.
A lender’s right to foreclose a property cannot be enforced as long as the borrower has the financial means to continue with repayments and do not breach any of the terms in the contract.
In some cases, mortgages are held as investments by investors and prepayment would affect the returns of their mortgage-backed securities in the portfolio. So any repayment attempt by the borrower can be refused.
A borrower can then build up a portfolio consisting of high quality bonds to offset the “losses” which investors would incur.
Prepayment might then be allowed.
A defeasance clause will also enable a borrower in default to redeem the property by paying the lender the full amount due.