Prepayment Penalty & Lockout

Commercial loans routinely restrict early payoff. A prepayment penalty charges the borrower for retiring the loan ahead of schedule — commonly a step-down (5-4-3-2-1% of balance by year), yield maintenance (a formula making the lender whole on the interest it expected), or, in CMBS, defeasance (substituting Treasury collateral). A lockout goes further and simply prohibits prepayment for an initial period. All exist because the lender priced the loan expecting a stream of interest.

The prepayment structure quietly determines a borrower’s flexibility to sell or refinance. Yield maintenance in a falling-rate environment can cost more than a year of interest, effectively welding the debt to the property; a step-down is predictable and cheap by the end of the term; bank loans with float or short fixed periods often prepay at par or with modest fees. Whatever your hold-period assumption is, the honest move is to price the scenario where you’re wrong.

Prepayment terms quoted by lenders in our coverage appear in the observed-terms module — one of the terms where banks differ most from debt funds and CMBS.