What is Defeasance?§
Defeasance is like your finance fairy godmother—poof! With the right amount of cash or bonds set aside, debts vanish from your balance sheet! Specifically, this provision in a contract allows a borrower to void a bond or loan from their financial statements when they set aside the necessary cash or bonds. Think of it as a magical shield against unwanted interest payments— your outstanding debt and cash intelligently offset each other, making them mysteriously disappear from your accounting records.
Defeasance Definition§
Formal Definition: A contractual provision that voids the recording of a bond or loan when the borrower has set aside enough cash or bonds to fully service that debt.
Defeasance vs. Prepayment Comparison§
| Feature | Defeasance | Prepayment |
|---|---|---|
| Definition | Voids debt on balance sheet by setting aside cash/bonds | Paying off a loan or bond prematurely |
| Impact on Records | Debt removed from balance sheet | Debt is still recorded, but payment reduces outstanding principal |
| Interest Payments | No ongoing payments after defeasance | Potentially less interest paid, but payments continue until paid off |
| Use Case | Ideal when expecting high cash flow for investment | Best when lower interest rates become available |
Examples§
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Example 1: A corporation has a $5 million bond outstanding. By setting aside $5 million in cash equivalent to the future payments, they can remove the liability from their balance sheet. It’s as if they pulled a disappearing act right out of a magician’s hat!
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Example 2: A homeowner has a mortgage with a high-interest rate but has come into an inheritance. Instead of simply prepaying the mortgage and maintaining a record of it, they can defease the mortgage by setting aside enough cash to cover all coming payments, effectively wiping it from their records.
Related Terms§
- Prepayment Penalty: A fee charged when a borrower pays off a loan before the designated due date.
- Amortization: The gradual reduction of a debt over time through scheduled payments.
Fun Facts & Humorous Anecdotes§
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Did you know? The term “defeasance” comes from the Latin word “defeasare,” which means “to undo.” Luckily, our debts do not get their own Latin plays, else we’d be paying the writers!
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Quotation: “Debt is like the teenage years—full of awkward moments, but it can eventually be swept under the carpet with a good cash plan!”
Frequently Asked Questions§
Q1: Is defeasance common in real estate financing?
A1: Yes, many real estate investors use defeasance to clean their balance sheets, especially when managing large portfolios.
Q2: Can defeasance be used for all types of debt?
A2: Not all debts can be defeased; it primarily applies to bonds and loans with designated contracts allowing for such provisions.
Q3: What happens if the reserved cash is not enough to cover the debt?
A3: If the cash or bonds set aside cannot service the debt, the defeasance may not be recognized, leaving the borrower with both a liability and a burden! 🙃
Suggested Online Resources & Books for Further Study§
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Online Resources:
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Suggest Book:
- “The Debt-Free Blueprint” by David Bonhomme – A motivational take on how managing debt smartly can lead to financial freedom.
Test Your Knowledge: Defeasance Quiz Challenge!§
Thank you for diving into the enchanting world of defeasance! Remember, in finance, sometimes having cash is the real magic trick! ✨
