Lock-In Clause

“Lock-In” Clause Definition

A “lock-in” clause is a clause in a debt instrument that prohibits an early retirement of the debt for a specific period of time, or in some cases, for the entirety of the debt instrument duration.

Explanation

Historically there have been many reasons for lock-in clauses. In connection with real estate, a lender loans money to a borrower at a certain interest rate, and wants to make sure that he will continue to receive that rate of interest for a specific length of time, because the interest rate is higher than the lender would receive by putting his money in the stock market.

When used, it is most usually seen in privately carried real estate contracts and deeds of trust.

A seller sells his house to a buyer, and the buyer is going to make monthly payments to the seller, and the seller agrees to “carry the contract” at a certain interest rate for a certain number of years. The vast majority of such private agreements include language that protects the buyer, allowing early payoff at any time the buyer selects.

But in some instances, the seller, aka the “holder of the note”, may suffer negative income tax ramifications if the buyer pays the note off early. In connection with commercial or institutional lenders, the desire to receive a certain interest rate for a certain period of time actually gave rise to “early payoff penalties” in the past.

 

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