Lockout Period

How a lockout period works

When a commercial lender funds a loan, it is buying a stream of payments. The longer that stream is guaranteed, the more precisely the lender (or the investors who bought the loan from it) can price the debt. A lockout period is the strongest form of that guarantee: for a defined number of years after the loan closes, the borrower may not prepay.

The clause sits in the prepayment section of the promissory note and usually reads something like “borrower may not prepay the loan, in whole or in part, prior to the Permitted Prepayment Date.” The date it points to is the first day the loan is open to some form of payoff, and what happens on that day is the real cost of the loan to anyone planning a refinance or sale.

A typical fixed-rate commercial loan therefore moves through up to three phases:

• Lockout — no prepayment permitted. Commonly one to five years; sources vary because lenders and loan types differ.
• Restricted prepayment — payoff is allowed, but at a price: defeasance, yield maintenance or a step-down schedule such as 5-4-3-2-1.
• Open period — the final stretch before the maturity date, often a few months, when the loan can be repaid at no cost. Freddie Mac’s standard structure, for example, has no prepayment premium in the last 90 days.

Not every loan has all three. Bank loans and many bridge loans have no lockout at all, and some loans move straight from lockout to open.

Why CMBS loans lock out for about two years

The two-year lockout on a CMBS loan is not simply a lender preference; it comes from tax law. Conduit loans are pooled into a trust that elects REMIC status, which keeps the trust from being taxed as a corporation. To stay a qualified mortgage inside the REMIC, a loan cannot have its collateral released casually. Treasury Regulation 26 CFR 1.860G-2(a)(8) allows the lien on the property to be released in exchange for substitute collateral made up solely of government securities, but only if, among other conditions, the release does not happen within two years of the REMIC’s startup day.

That is where defeasance gets its calendar. In practice, most conduit loans bar both prepayment and defeasance until about two years after securitization, then allow defeasance until the open period at the end. This is also why a CMBS note typically will not let you simply wire a payoff plus a fee: the structure the investors bought depends on the payments continuing.

Agency loans follow a similar logic. Freddie Mac’s standard fixed-rate prepayment provision for loans it securitizes is yield maintenance until securitization, then a two-year lockout, then defeasance, with no premium in the final 90 days. If the loan is not securitized within a year of origination, yield maintenance continues until the final 90 days instead. Fannie Mae’s fixed-rate loans generally use yield maintenance for a period the borrower chooses, commonly ending about six months before maturity, after which the loan is open to prepayment. For how these programs fit into the market, see agency loans. Life insurance companies use lockouts for a different reason: they match a loan to a long-term obligation and want the income held for a minimum period.

Worked example: what a two-year lockout costs

Start with the site’s standard example: a $2,000,000 purchase with a $1,400,000 loan (70% LTV). Assume a 10-year term, 30-year amortization and a 7.00% fixed rate. Using the commercial mortgage calculator, the payment is $9,314 a month, and after two years the balance is $1,370,529. (Rates here are illustrative; current ranges are on the rates page.)

Suppose rates fall to 6.00% right after closing. A 6.00% loan on the same $1,400,000 would be $8,394 a month, a difference of $920 a month, or $11,040 a year. A two-year lockout means you cannot capture that saving for 24 months. Nothing here is a penalty you pay; it is an opportunity you cannot take.

Now the exit. When the lockout ends and defeasance opens, assume (to keep the arithmetic simple, rounding the $1,370,529 balance up to $1,400,000) a $1,400,000 balance, a 7.00% note rate, 96 months remaining, a 4.00% Treasury yield and $40,000 of consultant, legal and servicer fees. The defeasance calculator gives:

Component	Amount
Securities premium (cost of the bond portfolio above the balance)	$165,901
Legal, consultant and servicer fees (assumed)	$40,000
Total defeasance cost	$205,901 (14.71% of balance)

Against a saving of $920 a month, $205,901 takes roughly 224 months, or more than 18 years, to earn back, longer than the loan itself. The lockout kept you from refinancing in years one and two, and the cost of leaving afterward makes the refinance uneconomic anyway. That is the full picture of what a lockout plus defeasance asks of a borrower, and the reason to model the exit before you accept the loan. The refinance breakeven calculator runs the same test with your numbers. All figures are estimates; the servicer’s payoff quote governs.

Lockout vs. prepayment penalty vs. open period

• Lockout — prepayment is prohibited. The question is when it ends.
• Prepayment penalty — prepayment is allowed for a fee. See pre-payment penalty and the guide to commercial loan prepayment penalties.
• Soft lockout — the early years allow payoff, but only with a stiff premium such as yield maintenance. In effect a penalty that is meant to deter. A “hard” lockout allows nothing.
• Open period — prepayment is free, normally just before maturity.

The practical difference is certainty. A step-down penalty gives you a number to plan around from the first day. A lockout gives you a date instead, and before that date the number is not available at any price.

Why lenders care

From the lender’s side, a lockout buys two things: income and predictability. A loan that can be paid off in month 14 earns far less than the lender priced; a loan that is locked out for 24 months cannot. That is why a longer lockout or a more restrictive prepayment structure generally leads to better pricing: a lender holding a guaranteed stream of payments can offer a lower rate than one who might be repaid early. The rates page makes the same point: accepting defeasance or yield maintenance lowers your rate relative to flexible prepayment.

For securitized loans there is a second reason: the trust and its investors, not the originating lender, own the loan, and the servicer has little discretion. A servicer who accepts a prepayment the documents forbid is acting against the agreement it administers for the investors. That is why asking a CMBS servicer to “make an exception” rarely works, while asking a portfolio bank to soften its terms sometimes does.

Common misunderstandings

“I can always pay it off if I pay the fee.” Not during a lockout. The fee structures in the other provisions only begin when the lockout ends.

“Lockout means I can’t sell.” It means you cannot repay the loan. A sale to a buyer who assumes the loan, with the lender’s approval, is a different transaction, which is why assumability matters so much on locked-out loans.

“The lockout and the loan term are the same thing.” The lockout is only the first part of the term. A ten-year loan with a two-year lockout is open to some form of payoff for eight of its ten years.

“Extra principal payments are allowed.” During a lockout, usually not; partial prepayments are prepayments. Some loans permit a small annual paydown after the lockout, so ask.

What to watch for and how to negotiate

• Match the lockout to your business plan. If you might sell or refinance in three years, a five-year lockout on top of defeasance is a poor fit. A shorter fixed term, a step-down structure or a loan with no lockout, such as a bank loan or permanent financing sized for flexibility, may be worth a higher rate. Typical CMBS terms are 5–10 yr; long enough that your plan should outlast the lockout.
• Read the start date. Does the lockout run from closing, from the first payment date or from securitization? On Freddie Mac loans it is securitization. On CMBS notes the date defeasance opens is often tied to both the securitization date and the closing date, so find the exact trigger in the note. The difference can add months.
• Check what happens after. A two-year lockout followed by defeasance is a very different loan from a two-year lockout followed by a 3-2-1 step-down.
• Look for exceptions. Ask what the note says about casualty and condemnation proceeds, partial releases (blanket loans) and a cure after a default. These are rarely negotiable after closing.
• Plan the sale route in advance. During a lockout, a sale usually means a buyer who assumes the loan. Confirm that the loan is assumable, what the lender must approve and what it costs; see loan assumption. Selling with an assumable, below-market loan can even help the price.
• Ask for the dates in writing. Get the lockout end date, the first date prepayment is permitted, and the open period start date as calendar dates on the term sheet, not just as phrases. Tie them to your exit strategy.
• Negotiate before the term sheet is signed. It is much harder to change a lockout later, and a lender with the loan on its own books has far more flexibility than a conduit lender who is selling the loan into a trust. Expect to give something in return, most likely rate or leverage.

If you want the prepayment terms of competing offers compared side by side, submit a commercial real estate loan application and ask that the lockout, defeasance and open-period dates be laid out for each.

Sources: 26 CFR 1.860G-2(a)(8) (REMIC qualified mortgage; release of lien with government securities not within two years of the startup day). Freddie Mac fixed-rate multifamily prepayment structure, as published in Freddie Mac’s fixed/floating note comparison and lender term sheets. Fannie Mae yield maintenance periods, per Fannie Mae multifamily documents. Definitions of lockout periods: Adventures in CRE glossary; Barnes Walker legal glossary. Worked figures use BestLoanUSA’s commercial mortgage and defeasance calculators and are estimates.