It depends on the lender, and most term debt carries some cost for leaving early. Many variable-rate bank loans carry no penalty, while fixed-rate bank loans often carry a step-down fee, yield maintenance or swap breakage. Private credit and unitranche loans usually carry call protection for their first years: a soft call, or premiums that step down to nothing. Mezzanine is heavier, with a non-call period or make-whole before declining premiums. Price the exit you are most likely to make, and negotiate what the premium applies to as hard as its size.
- Variable-rate bank loans
- Often no penalty
- Fixed-rate bank loans
- Step-down fee, yield maintenance or swap breakage
- Private credit and unitranche
- Soft call or step-down premiums in the early years
- Mezzanine
- A non-call period or make-whole, then declining premiums
- What usually triggers it
- A refinancing, repricing or sale; sweeps and casualty proceeds are often carved out
Why lenders charge you for leaving early
A lender prices a loan to earn a return over a period of time. Origination, diligence and legal work are front-loaded, and a lender that is repaid after a year has done all of that work for a year of interest. A lender that has fixed your rate may have funded it with fixed-rate money or a swap, and unwinding that costs something when rates have moved. Call protection pays for both.
There is a third reason, and it is the one borrowers feel. The borrowers most likely to repay early are the ones doing well: their earnings grow, their leverage falls, and a cheaper lender offers to refinance them. A lender that lent at a higher rate when the credit was riskier wants to be compensated if it loses the loan the moment the risk goes away. That is why protection is heaviest on the most expensive debt, and lightest on bank loans that were priced for a strong credit in the first place.
Call protection is a bet on your success. The better the business does, the more likely you are to pay it.
The structures, from lightest to heaviest
| Structure | How it works | Where you see it | What leaving early costs |
|---|---|---|---|
| Open prepayment | Repay any time at par | Many variable-rate bank loans and lines of credit | Nothing beyond accrued interest |
| Soft call | A small premium, but only if the loan is refinanced or repriced during the protection period | Private credit and unitranche term loans | Little, and often nothing if repaid from a sale or cash flow; read the definition |
| Step-down schedule | A fee that declines each year to zero | Fixed-rate bank loans, private credit, mezzanine after a non-call period | Known in advance; highest in the first year |
| Swap breakage | Where a fixed rate comes from an interest rate swap, ending it early settles the swap at its market value | Bank term loans hedged with a swap | A cost if rates have fallen, sometimes a gain if they have risen |
| Yield maintenance or make-whole | Pays the lender the interest it would have earned through a set date, discounted back at a Treasury-based rate | Fixed-rate real estate loans, mezzanine, some private credit | Heavy, and heavier when rates have fallen |
| Non-call or lockout | No prepayment allowed during the period, or only with a make-whole | Mezzanine and some private placements | The highest cost, or no exit at all |
Step-down and make-whole structures behave very differently when rates fall, which is exactly when owners want to refinance. The comparison of yield maintenance vs step-down prepayment works through both. Swap breakage is not a penalty at all in the legal sense, but it has the same effect; swaps vs rate caps explains why a cap carries no breakage and a swap can, and when lenders require a hedge in the first place.
Call protection on fund loans, in detail
Private credit, unitranche and mezzanine lenders write call protection as a schedule in the credit agreement. There may be a first stage in which prepayment is barred or costs a make-whole, then premiums charged on the amount prepaid that fall each year until the loan can be repaid at par. How long each stage lasts and how large each premium is are negotiated deal by deal. They follow from the lender's return target and from how likely it thinks an early exit is, which is why a company already talking to buyers gets heavier protection than one with no plans to sell.
The definitions decide more than the schedule. A premium applies to whatever the agreement calls a prepayment event, and that list usually includes a voluntary prepayment, a refinancing with new debt, a sale of the company and, under a soft call, a repricing: an amendment that lowers the spread. Just as important is what is left out. Payments the lender itself requires, such as an excess cash flow sweep or insurance proceeds after a loss, are commonly excluded, and proceeds of an asset sale often are. A borrower who never reads past the schedule can find that a routine paydown carries a premium the owners assumed it did not.
The case that costs owners most is a sale. A buyer almost never assumes the seller's debt: the loan is repaid at closing under the change-of-control clause, and any premium comes out of the seller's proceeds. An owner who expects to sell within the protection period should either negotiate a reduced premium on a change of control or weigh a loan with lighter protection at a higher rate. The comparison below shows how to put a number on that choice.
Pricing a likely exit into the comparison
The right way to compare two offers is to estimate when you are likely to repay and add everything each loan would cost you up to that point: interest, upfront fees and the prepayment cost in that year. The lower rate does not always win.
Suppose two offers on a loan of 10,000, ignoring amortization for simplicity. Offer A charges interest of 800 a year with a step-down premium of 300 if repaid in year one, 200 in year two, 100 in year three and nothing after. Offer B charges 900 a year and has no premium.
| Repaid | Offer A: interest plus premium | Offer B: interest only | Cheaper |
|---|---|---|---|
| During year one | 800 + 300 = 1,100 | 900 | B |
| During year two | 1,600 + 200 = 1,800 | 1,800 | Even |
| During year three | 2,400 + 100 = 2,500 | 2,700 | A |
| Held five years | 4,000 | 4,500 | A |
If a sale is likely inside two years, the higher-rate loan with no protection is the cheaper one. If the business will keep the loan, the lower rate wins easily. Most owners do not know their exit date for certain, so the useful question is how likely each case is. An owner who has already had approaches from buyers, expects to move from a fund loan back to a bank once leverage falls, or plans to replace expensive mezzanine debt once leverage falls should weight the early years heavily.
The same arithmetic runs through the refinance break-even calculation from the other side: the premium on the old loan is one of the costs the new loan's savings must cover. Interest rate vs all-in cost puts the upfront fees into the same comparison, and private credit pricing shows where call protection sits among a fund lender's other terms.
What to negotiate
Call protection is one of the more negotiable terms in a credit agreement, because lenders care about its economics more than its form. Ask for it early, while there are competing offers.
- A shorter protection period, or a step-down in place of a make-whole.
- Soft call in place of hard call, so the premium applies only to a refinancing or repricing, not to a paydown from cash flow.
- Carve-outs for mandatory prepayments the lender itself requires: an excess cash flow sweep, insurance and casualty proceeds, and proceeds of asset sales.
- An annual free prepayment basket, so part of the loan can be repaid each year at par.
- A reduced premium on a sale of the company. A sale normally forces repayment through the change-of-control clause, so without this the premium lands on the seller. See what happens to a loan when you sell.
- A make-whole discount rate with a spread over Treasuries, which lowers its cost, if a make-whole cannot be avoided.
- Clarity on what the premium is charged on: the amount prepaid, not the whole commitment.
Protection is written into the term sheet and carried into the credit agreement, and it is hard to reopen later. The page on term sheets, commitment letters and credit agreements covers when those terms become binding. When Midas Partners runs a financing, each lender's call protection is laid out next to its rate and fees in the financing model, so the comparison reflects the exit the owner actually expects. Senior bankers run every engagement, and with 1,148 lenders in the book writing term and private credit, there are usually offers on both sides of the trade between rate and protection to compare.
Common questions
- Does a repricing count as a prepayment?
- Often, during the protection period. Soft call protection is written to catch an amendment that lowers the spread as well as a refinancing, so asking your lender to reprice early can cost a premium on the repriced amount. Read the definition before asking, and time the request for when protection ends.
- Does selling my business trigger a prepayment penalty?
- Usually. A sale normally requires the loan to be repaid at closing, and the prepayment terms apply unless the loan documents carve out a change of control. Negotiate that carve-out, or a reduced premium, when the loan is signed.
- Is a make-whole negotiable?
- The period and the discount rate often are. Asking for a Treasury rate plus a spread as the discount rate lowers the cost, and asking for a make-whole that ends after a set period, followed by step-down premiums, limits it.
- What is swap breakage?
- If your fixed rate comes from an interest rate swap, ending the loan early also ends the swap, which is settled at its market value. If rates have fallen since you fixed, you pay; if they have risen, you may receive a payment.
- Do bank lines of credit carry prepayment penalties?
- Rarely. Revolving lines are designed to be drawn and repaid. The cost to watch on a line is usually an unused fee or an early termination fee if the whole facility is ended before its maturity.