Yield maintenance

Yield maintenance makes lender indifferent to an early prepayment. If the borrower wants to pay loan early, the yield maintenance requires him to pay all the interest, as if the loan was paid on the date of maturity. That isn't, however, profitable for borrower, who will have to pay all the interest, instead of the fact of early payment.

The yield maintenance usually is related to some percentage of the interest to be paid or to value of e.g. treasury notes. Therefore there is no one formula for calculating yield maintenance penalty. An example formula can be:

YM = PV * (IR - TY)

where:

  • YM - yield maintenance
  • PV - present value of remaining payments
  • IR - interest rate
  • TY - treasury yield

The present value is calculated using discount ratio based on treasury yield.

References

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