If mortgage rates decline significantly, borrowers may decide to prepay the principal on their loan even if they face prepayment penalties. One way that lenders protect themselves from prepayments in such circumstances is by requiring the borrower who prepays to purchase for the lender a set of U.S. Treasury securities whose coupon payments replicate the cash flows the lender will lose as a result of the early retirement of the mortgage. This process is referred to as?

Defeasance , in law, an instrument which defeats the force or operation of some other deed or estate; as distinguished from condition, that which in the same deed is called a condition is a defeasance in another deed.

The provision includes various requirements that must be met, most often by the buyer, before the seller is required to release his interest in a particular property. Defeasance entails a borrower setting aside sufficient funds, often in cash and bonds, to cover his or her associated debts. This functions as a way to render the debt obligation null and void without the risk of prepayment penalties. Since the amounts owed and the amounts set aside offset, they are functionally removed from balance sheet as monitoring the accounts is generally unnecessary.