How do agency prepay options work, yield maintenance vs. declining vs. open?

Cost profile under different rate environments

Yield maintenance: cost depends entirely on the spread between the loan's contract rate and the current Treasury at prepay date. When current Treasuries are at or above the contract rate, YM cost is typically minimal (often subject only to a defined floor of 1% of balance). When current Treasuries are well below the contract rate, YM cost can be material: 5% to 15%+ of balance is common when rates have dropped 100+ bps from origination.

Declining-percentage: predictable cost. Standard 5-4-3-2-1 structure means 5% premium in year 1, 4% in year 2, declining to 1% in year 5, with the final 90 days open. The cost is rate-environment-independent, pay the percentage regardless of whether rates have moved up or down.

Trade-off: YM is cheaper than declining when rates rise after origination (often free or near-free); declining is cheaper than YM when rates fall sharply after origination (the borrower locked in fees rather than facing market-determined cost).

Open window (last 90 days): standard on every agency loan. Allows the sponsor to time a refi or sale into the back end of the loan term without prepay penalty. The 90-day window can be material in volatile rate environments; sponsors with flexibility on closing timing can target the window to optimize the refi rate.

Selection logic: borrowers planning to hold to maturity often have no preference because neither structure will be triggered. Borrowers planning a refi within the first half of the loan often choose YM (typically cheaper if rates rise) or declining (more predictable). Run the comparison at term sheet using the borrower's actual hold horizon and a forward-rate scenario.