A predetermined period of time following loan origination in which the loan cannot be prepaid, as set forth in the loan documents. The lock-out period can vary greatly from no lockout period at all to nearly the entire loan term. From a lender’s perspective, a lock-out clause is a form of call protection as it prevents prepayment. There is considerable time and effort involved to underwrite and originate a loan, thus the lender wants to ensure a certain level of minimal return on the loan.
Lock-out period terms can vary across lenders. While the lock-out is meant to protect the lender from prepayment, it doesn’t mean prepayment isn’t allowed. Some lenders will accept full or partial prepayment but for a fee. The fee is calculated to offset lost interest due to the prepayment. For the borrower, fee-based prepayment can make sense if it costs less than the interest will accumulate over the loan term.
The prepayment penalty is also called a premium. This premium can be a fixed rate that decreases in brackets depending on the years remaining in the loan. For example, the first five years may have a 5% premium. The next five years will reduce to 4% and continue in this manner until the last five years have no premium. In other words, the last five years don’t have a prepayment penalty. The exact structure will be based on the loan’s terms.
The lock-out period shouldn’t be confused with the lock period. The lock period lasts about 30 to 90 days, at which time loan terms are locked. This is often used on a mortgage when buying a home. It allows the borrower to lock in loan terms, including the interest rate (called a mortgage rate lock). Since interest rates can fluctuate, the borrower protects herself from a potentially rising rate. The lock period doesn’t mean the borrower has accepted the loan.