What is a lockout period in a commercial mortgage?

What is a Lockout Period Prepayment Penalty?

A lockout period in a commercial mortgage is a clause that prohibits the borrower from paying off the loan for a set period after origination, typically ranging from one to several years. This period ensures the lender receives a consistent stream of interest payments, securing their yield on the investment. After the lockout period, other types of prepayment penalties may apply, making it essential for borrowers to consider these restrictions in their long-term financial planning.

Here's how it works:

  1. Duration of the Lockout: The lockout period is set at the inception of the loan and can vary in length, often ranging from one to several years.
  2. Prepayment Restriction: During this period, the borrower is not allowed to make any prepayments on the principal balance. This means the borrower cannot refinance or pay off the loan early.
  3. Protects Lender’s Interest: The lockout period protects the lender’s yield on the loan by ensuring that they receive a predictable stream of interest payments for a certain period, without the risk of early loan payoff.
  4. After the Lockout Period: Once the lockout period expires, the loan may become open to prepayment, often subject to other types of prepayment penalties, such as step-down or yield maintenance penalties, depending on the loan terms.
  5. Consideration for Borrowers: Borrowers need to consider the lockout period when planning their long-term financial strategy, as it limits their flexibility to refinance or sell the property during this time.

A lockout period is essentially just a timeframe in a commercial mortgage during which the borrower is restricted from paying off the loan, serving to protect the lender's expected income from interest payments.

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